UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q


þ		QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended June 30, 2006


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

For the transition period from to

333-123664

(Commission File number)

UGS Corp.

(Exact name of Registrant as specified in its charter)


Delaware		75-2728894
(State or other jurisdiction of		(I.R.S. Employer
incorporation or organization)		Identification No.)

5800 Granite Parkway, Suite 600
Plano, TX 75024
(Address of principal executive offices, including zip code)

(972) 987-3000
(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 Company was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes o No þ

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer o Accelerated filer o Non-accelerated filed þ

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes o No þ

On July 31, 2006, 100 shares of the Registrant’s Common Stock, $.01 par value, were outstanding.

UGS CORP.
INDEX TO FORM 10-Q


		Page
Part I.	FINANCIAL INFORMATION
Item 1.	Financial Statements (Unaudited)

	Condensed Consolidated Statements of Operations for the three months ended June 30, 2006 and 2005		1

	Condensed Consolidated Statements of Operations for the six months ended June 30, 2006 and 2005		2

	Condensed Consolidated Balance Sheets as of June 30, 2006 and December 31, 2005		3

	Condensed Consolidated Statements of Cash Flows for the six months ended June 30, 2006 and 2005		4

	Notes to Condensed Consolidated Financial Statements		5

Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations		25

Item 3.	Qualitative and Quantitative Disclosures About Market Risk		43

Item 4.	Controls and Procedures		44

Part II.	OTHER INFORMATION

Item 1A.	Risk Factors		45

Item 6.	Exhibits		54

	Signatures		55
Certification of President and Chief Executive Officer
Certification of Chief Financial Officer
Section1350 Certifications

UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands)


	Three months
	ended
	June 30, 2006			June 30, 2005
Revenue:
License	$	86,017		$	81,777
Maintenance		135,142			128,301
Services and other		75,500			74,932

Total revenue		296,659			285,010

Cost of revenue:
License		2,175			5,944
Maintenance		15,695			14,495
Services and other		57,167			66,701
Amortization of capitalized software and acquired intangible assets		37,713			31,038

Total cost of revenue		112,750			118,178

Gross profit		183,909			166,832

Operating expenses:
Selling, general and administrative		117,850			110,410
Research and development		47,388			38,659
In-process research and development		—			4,100
Restructuring		—			1,774
Amortization of other intangible assets		8,547			8,739

Total operating expenses		173,785			163,682

Operating income		10,124			3,150
Interest expense and amortization of deferred financing fees		(26,520	)		(25,216	)
Other income (expense), net		7,703			(8,583	)

Loss before income taxes		(8,693	)		(30,649	)
Benefit for income taxes		(2,274	)		(8,625	)

Net loss	$	(6,419	)	$	(22,024	)

See accompanying notes to unaudited condensed consolidated financial statements.

UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(in thousands)


	Six months
	ended
	June 30, 2006			June 30, 2005
Revenue:
License	$	165,527		$	154,896
Maintenance		260,831			239,908
Services and other		144,095			142,771

Total revenue		570,453			537,575

Cost of revenue:
License		6,099			10,400
Maintenance		30,800			27,858
Services and other		113,015			122,697
Amortization of capitalized software and acquired intangible assets		74,759			57,224

Total cost of revenue		224,673			218,179

Gross profit		345,780			319,396

Operating expenses:
Selling, general and administrative		225,661			205,579
Research and development		98,613			74,640
In-process research and development		—			4,100
Restructuring		(535	)		1,774
Amortization of other intangible assets		17,366			16,309

Total operating expenses		341,105			302,402

Operating income		4,675			16,994
Interest expense and amortization of deferred financing fees		(52,967	)		(46,379	)
Other income (expense), net		9,937			(13,407	)

Loss before income taxes		(38,355	)		(42,792	)
Benefit for income taxes		(12,782	)		(12,599	)

Net loss	$	(25,573	)	$	(30,193	)

See accompanying notes to unaudited condensed consolidated financial statements.

UNAUDITED CONDENSED CONSOLIDATED BALANCE SHEETS

(in thousands, except share amounts)


	June 30, 2006			December 31, 2005
Assets:
Current assets
Cash and cash equivalents	$	61,472		$	61,532
Accounts receivable, net		258,645			251,763
Prepaids and other		29,206			22,389
Deferred income taxes		17,351			26,471

Total current assets		366,674			362,155


Property and equipment, net		32,031			36,645
Goodwill		1,416,422			1,393,472
Capitalized and acquired software, net		434,919			464,994
Customer accounts, net		190,095			203,064
Other intangible assets, net		124,032			135,265
Other assets		36,910			39,623

Total assets	$	2,601,083		$	2,635,218


Liabilities and Stockholder’s Equity:
Current liabilities
Accounts payable and accrued liabilities	$	146,489		$	159,976
Deferred revenue		173,827			133,027
Income taxes payable		9,245			11,895
Current portion of long-term debt		6,500			—

Total current liabilities		336,061			304,898


Other long-term liabilities		63,770			48,511
Deferred income taxes		107,706			147,440
Long-term debt		1,180,970			1,212,046

Stockholder’s equity
Common stock, $ .01 par value, 3,000 shares authorized; 100 issued and outstanding at June 30, 2006 and December 31, 2005		—			—
Additional paid-in capital		1,011,626			1,005,991
Retained deficit		(88,775	)		(63,202	)
Accumulated other comprehensive loss, net of tax		(10,275	)		(20,466	)

Total stockholder’s equity		912,576			922,323

Total liabilities and stockholder’s equity	$	2,601,083		$	2,635,218

See accompanying notes to unaudited condensed consolidated financial statements.

UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)


	Six months
	ended
	June 30, 2006			June 30, 2005
Cash flows from operating activities
Net loss	$	(25,573	)	$	(30,193	)
Adjustments to reconcile net loss to net cash provided by operating activities:
Benefit for deferred income taxes		(17,282	)		(25,740	)
Depreciation and amortization		102,726			81,403
Amortization of deferred financing fees		2,765			2,842
In-process research and development		—			4,100
Stock-based compensation		252			154
Unrealized (gain) loss on revaluation of foreign denominated assets and liabilities		(16,935	)		23,486
Unrealized loss (gain) on foreign currency revaluation of derivative instruments		7,078			(16,965	)
Other		3,663			2,239
Changes in operating assets and liabilities, net of effect of acquisitions:
Accounts receivable		2,874			4,385
Prepaids and other		(6,058	)		(1,405	)
Accounts payable and accrued liabilities		(21,740	)		(10,894	)
Deferred revenue		33,952			46,982
Income taxes payable		(7,217	)		54
Other long-term liabilities		2,509			(164	)

Total adjustments		86,587			110,477

Net cash provided by operating activities		61,014			80,284


Cash flows from investing activities
Acquisitions, net of cash acquired		—			(218,392	)
Acquired software		(4,000	)		—
Cash received from prior parent for acquisition related tax matters		—			14,871
Payments for purchases of property and equipment		(4,560	)		(5,804	)
Capitalized software costs		(34,155	)		(39,445	)
Proceeds from sale of marketable securities		—			23,194
Other		(368	)		(62	)

Net cash used in investing activities		(43,083	)		(225,638	)


Cash flows from financing activities
Proceeds from revolver credit line		78,800			81,351
Payments on revolver credit line		(72,300	)		(87,351	)
Proceeds from note payable		5,951			6,802
Payments on notes payable		(345	)		(2,773	)
Proceeds from bank notes and bonds, net		—			234,094
Payments on bank notes and bonds		(37,000	)		(69,351	)
Capital contributed by parent (stock options exercised)		553			508
Capital contributed by parent (compensatory payment)		3,819			—

Net cash (used in) provided by financing activities		(20,522	)		163,280

Effect of exchange rates on cash and cash equivalents		2,531			(3,252	)

Net (decrease) increase in cash and cash equivalents		(60	)		14,674
Cash and cash equivalents at beginning of period		61,532			58,400

Cash and cash equivalents at end of period	$	61,472		$	73,074

See accompanying notes to unaudited condensed consolidated financial statements.

UGS Corp.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—
(Continued)

Note 1: Basis of Presentation

On May 27, 2004, UGS Corp. (“the Company”), a newly formed Delaware corporation, acquired all of the stock of UGS PLM Solutions Inc. from Electronic Data Systems Corporation (“EDS”). Immediately following the acquisition from EDS, UGS Corp. merged with and into UGS PLM Solutions Inc., with UGS PLM Solutions Inc. continuing as the surviving corporation. In connection with that merger, UGS PLM Solutions Inc. changed its name to UGS Corp.

The Company is a wholly owned subsidiary of UGS Holdings, Inc., which is a wholly owned subsidiary of UGS Capital Corp. II, which is a wholly owned subsidiary of UGS Capital Corp. UGS Capital Corp., UGS Capital Corp. II and UGS Holdings, Inc., which are collectively referred to as the Parent Companies, were formed in March 2004 for the purpose of acquiring and holding the stock of the Company.

The accompanying unaudited condensed consolidated financial statements include the accounts of the Company and its subsidiaries and, in the opinion of management, reflect all adjustments (consisting only of normal recurring adjustments) necessary to fairly state the Company’s consolidated financial position, results of operations, and cash flows as of and for the dates and periods presented. The results for such periods are not necessarily indicative of the results to be expected for the entire fiscal year or for any future period. The condensed consolidated balance sheet at December 31, 2005 has been derived from the audited 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 of America for complete financial statements. These condensed consolidated financial statements are meant to be, and should be, read in conjunction with the December 31, 2005 consolidated financial statements and the notes thereto included in the Company’s Annual Report on Form 10-K (File No. 333-123664) as filed with the Securities and Exchange Commission on March 9, 2006.

The unaudited condensed consolidated financial statements were prepared in conformity with accounting principles generally accepted in the United States of America which require management to make assumptions and estimates that affect the amounts reported in these statements. Those items requiring assumptions and estimates include capitalized software development costs, revenue recognition, business combinations, income taxes and recoverability of goodwill, acquired intangible assets and long-lived assets. Actual results may differ from these estimates.

Certain prior year amounts in the consolidated financial statements have been reclassified to conform to the current period presentation.

Note 2: Stock-Based Compensation

Effective January 1, 2006 the Company adopted the provisions of “Statement of Financial Accounting Standards (“SFAS”) No. 123 (R), “Share-Based Payment” and its related interpretations. Previously, as permitted by SFAS No. 123, “Accounting for Stock-Based Compensation”, the Company accounted for its stock option and retention incentive plans in accordance with Accounting Principles Board (“APB”) Opinion No. 25, “Accounting for Stock Issued to Employees”, and recorded no charges (except to the extent required by APB Opinion No. 25) against earnings with respect to options granted. The Company is considered a non-public entity as defined by both SFAS No. 123 and SFAS No. 123(R), and used the minimum value method of measuring equity share options for pro forma disclosure purposes under SFAS No. 123. Accordingly, the Company is required to apply the provisions of SFAS No. 123(R) prospectively to new awards and to awards modified, repurchased, or cancelled after the date of adoption. The Company has continued to account for any portion of awards outstanding at December 31, 2005 using the provisions of APB Opinion No. 25 as previously permitted under SFAS No. 123. In addition, the Company has discontinued pro forma disclosures previously required by SFAS No. 123 for equity share options accounted for using the intrinsic value method of APB Opinion No. 25.

UGS Corp.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—
(Continued)

For stock options granted or modified after January 1, 2006, the Company recognizes compensation cost associated with its stock-based awards to employees in accordance with SFAS No. 123(R). The Company records stock-based compensation over the requisite service period, or vesting period, at the grant date fair value determined using the Black-Scholes option pricing model. This model requires subjective assumptions, including expected stock price volatility, and expected term, which affects the calculated fair value on the grant date. Expected volatility is based upon equal weighting of both historical volatilities of stock prices and implied volatilities of traded options of comparable companies. Expected term is the average of the contractual term and vesting period of the options.

The following table summarizes the weighted average assumptions used in the estimated grant date fair value calculations for stock option and stock purchase awards:


	Three months			Six months
	ended			ended
	June 30, 2006			June 30, 2006
Expected term (in years)		7.5			7.5
Dividend yields		0	%		0	%
Expected volatility		44.68	%		43.25	%
Risk-free interest rate		5.10	%		4.62	%
Expected forfeiture rate		6.00	%		6.00	%

During the three months ended June 30, 2006, the aggregate grant-date fair value of options granted was $0.5 million, or $4.08 per share with approximately $57,000 of expense recognized in the statement of operations. The remaining unvested compensation cost will be recognized ratably over approximately five years.

During the six months ended June 30, 2006, the aggregate grant-date fair value of options granted was $1.6 million, or $4.08 per share, with approximately $98,000 of expense recognized in the statement of operations. The remaining unvested compensation cost will be recognized ratably over approximately five years.

During the three months ended March 31, 2005, the Company granted stock options with exercise prices below the estimated fair value of the common stock. The difference between the fair market value of these awards and their exercise price was a total of $1.5 million, which is being recognized as compensation expense over the five-year vesting period. For the six months ended June 30, 2006 and 2005, stock-based compensation expense recorded by the Company for these awards was $0.2 million.

Stock Option Plan

A summary of the stock option activity for UGS Capital Corp. Class A Common Shares under the 2004 Incentive Plan for the six months ended June 30, 2006 is reflected below:


						Weighted-
				Weighted-		Average
	UGS Capital Corp.			Average		Remaining		Aggregate
	Class A Common			Exercise		Contractual		Intrinsic
Fixed Options	Shares			Price		Term		Value
Outstanding at December 31, 2005		10,273,200		$	1.98
Granted		409,000			7.56
Exercised		(335,300	)		1.00
Forfeited		(202,683	)		1.00

Outstanding at June 30, 2006		10,144,217		$	2.25		8.36	$	51,228,296


Exercisable at June 30, 2006		3,075,350		$	1.29		8.16	$	18,482,854

UGS Corp.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—
(Continued)

Retention Incentive Plan

In June 2006, UGS Capital Corp. II offered to repurchase all the outstanding preferred shares with proceeds from the issuance of floating rate senior PIK notes. As of June 30, 2006 not all the preferred shares had been redeemed. A summary of the stock option activity for UGS Capital Corp. II preferred shares for the six months ended June 30, 2006 is reflected below:


						Weighted-
				Weighted-		Average
	UGS Capital Corp. II			Average		Remaining
	Preferred			Exercise		Contractual
Fixed Options	Shares			Price		Term
Outstanding at December 31, 2005		3,573		$	100.00
Exercised		(1,896	)		100.00

Outstanding at June 30, 2006		1,677		$	100.00		7.91


Exercisable at June 30, 2006		1,677		$	100.00		7.91

There was no activity of UGS Capital Corp. Class L common stock under the Retention Incentive Plan for the six months ended June 30, 2006. A summary of the UGS Capital Corp. Class L common stock options outstanding under the Retention Incentive Plan at June 30, 2006 is reflected below:

Weighted-

UGS Capital

Weighted-

Average

Corp. Class L

Average

Remaining

Common

Exercise

Contractual

Fixed Options

Shares

Price

Term

Outstanding and exercisable at June 30, 2006

12,712

7.91

Note 3: Property and Equipment

Property and equipment is stated net of accumulated depreciation of $27.1 million at June 30, 2006 and $19.2 million at December 31, 2005. The following is a summary of depreciation expense (in thousands):


	Three months
	ended
	June 30, 2006		June 30, 2005
Depreciation expense	$	4,200	$	3,243


	Six months
	ended
	June 30, 2006		June 30, 2005
Depreciation expense	$	8,576	$	6,269

Note 4: Goodwill

The following summarizes the changes in goodwill by reportable segment for the six months ended June 30, 2006 (in thousands):


	Americas			Europe			Asia Pacific			Total
Balance as of December 31, 2005	$	536,734		$	474,559		$	382,179		$	1,393,472
Tecnomatix purchase price allocation adjustments		(4,458	)		(9,195	)		(513	)		(14,166	)
Impact of foreign currency translation		—			37,116			—			37,116

Balance as of June 30, 2006	$	532,276		$	502,480		$	381,666		$	1,416,422

UGS Corp.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—
(Continued)

The purchase price allocation adjustments for the acquisition of Tecnomatix are primarily comprised of acquisition related income tax matters.

Note 5: Other Intangible Assets

Other intangible assets with definite useful lives are amortized over their respective estimated useful lives to their estimated residual values. As of June 30, 2006, the Company had no intangible assets with indefinite useful lives. The following is a summary of other intangible assets (dollars in thousands, life in years):


			June 30, 2006
	Weighted		Gross
	Average Useful		Carrying		Accumulated
	Life		Amount		Amortization		Total
Definite Useful Lives
Capitalized software		3.0	$	139,300	$	26,566	$	112,734
Acquired software		5.0		535,662		213,477		322,185
Customer accounts		10.0		242,273		52,178		190,095
Maintenance agreements		10.0		110,039		20,246		89,793
Noncompete agreements		2.0		11,460		9,704		1,756
Trademarks/tradenames		7.0		45,895		13,412		32,483

Total other intangible assets			$	1,084,629	$	335,583	$	749,046


			December 31, 2005
	Weighted		Gross
	Average Useful		Carrying		Accumulated
	Life		Amount		Amortization		Total
Definite Useful Lives
Capitalized software		3.0	$	105,035	$	10,743	$	94,292
Acquired software		5.0		529,789		159,087		370,702
Customer accounts		10.0		242,273		39,209		203,064
Maintenance agreements		10.0		110,039		14,744		95,295
Noncompete agreements		2.0		11,460		7,136		4,324
Trademarks/tradenames		7.0		45,787		10,141		35,646

Total other intangible assets			$	1,044,383	$	241,060	$	803,323

Amortization of software and maintenance agreements is included in cost of revenue. Amortization of customer accounts, noncompete agreements and trademarks/tradenames is included in operating expenses. The following is a summary of amortization expense (in thousands):


	Three months
	ended
	June 30, 2006		June 30, 2005
Capitalized software	$	8,182	$	1,601
Acquired software		26,058		26,001
Acquired and other intangible assets		13,001		13,024

Total amortization expense	$	47,241	$	40,626

Amortization of certain acquired software allocated to operating expense	$	981	$	849

UGS Corp.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—
(Continued)


	Six months
	ended
	June 30, 2006		June 30, 2005
Capitalized software	$	15,818	$	2,712
Acquired software		52,060		48,478
Acquired and other intangible assets		26,272		23,944

Total amortization expense	$	94,150	$	75,134


Amortization of certain acquired software allocated to operating expense	$	2,025	$	1,601

Estimated amortization expense related to intangible assets at June 30, 2006, for the remainder of 2006 and for each of the years in the five year period ending December 31, 2011 and thereafter is: remainder of 2006—$95.4 million; 2007—$194.6 million; 2008—$185.0 million; 2009—$103.1 million; 2010—$44.9 million, 2011—$36.9 million and all remaining years—$89.1 million.

Note 6: Restructuring Activities

The following table summarizes activity in the restructuring accruals for the six months ended June 30, 2006 (in thousands):


	Employee			Exit
	Separations			Costs			Total
Balance at December 31, 2005	$	3,778		$	13,324		$	17,102
Cash payments		(840	)		(3,120	)		(3,960	)
Reduction of accrual		(1,231	)		(2,758	)		(3,989	)

Balance at June 30, 2006	$	1,707		$	7,446		$	9,153

In April 2005, the Company acquired Tecnomatix and initiated restructuring activities designed to reduce the overall cost structure of the continuing organization. These activities provided for workforce reductions of approximately 140 people across all geographic segments totaling $8.1 million. The reductions affected individuals employed throughout the Company in selling, general and administrative, and research and development positions. In addition, the Company’s initiatives included exit costs, such as certain contract termination costs and the cost of redundant facilities, which totaled $6.3 million. The affected facilities have lease commitments that expire as late as April 2009. Restructuring activities associated with Tecnomatix were included in the fair value of the assets and liabilities as of the purchase date and totaled $6.3 million for workforce reductions and $6.3 million for exit costs. As such, these charges were not recognized in the statement of operations. The remaining restructuring activities of $1.8 million for workforce reductions were reflected as a restructuring expense in the statement of operations for 2005. At June 30, 2006, the balance of restructuring accruals related to Tecnomatix was $3.1 million.

The remaining balance of the accrual at June 30, 2006 was $6.0 million and represents restructuring activities done in conjunction with the acquisition of Engineering Animation Incorporated (“EAI”) in 2000 and the acquisition of Structural Dynamics Research Corporation (“SDRC”) in 2001. The Company added to the restructuring accrual in 2002 for activities associated with SDRC.

The reduction of accrual during the six months ended June 30, 2006 for employee separations was for activities associated with Tecnomatix. This included fewer workforce reductions and lower separation payments to employees than originally estimated. Of the $1.2 million reduction, $0.7 million was recorded to goodwill for the reductions associated with the acquired entity. The remaining $0.5 million related to workforce reductions of the Company and was recorded to restructuring in the statement of operations for the three months ended March 31, 2006. Adjustments recognized correspond to the same financial statement line item in which the original accrual was recorded.

The reduction of accrual during the six months ended June 30, 2006 for exit costs was due to the settlement in May 2006 with the Department of Commerce concerning the liability established for export

UGS Corp.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—
(Continued)

compliance issues at the acquisition of SDRC. The adjustment is reflected in the statement of operations as a reduction to cost of license revenue.

Note 7: Debt

Debt as of June 30, 2006 consists of the following (in thousands):


Note payable, due December 31, 2014 (1,573.1 million yen)	$	13,670
Revolving credit facility, due May 27, 2010, LIBOR plus 2.50%		6,500
Senior unsecured subordinated notes, due June 1, 2012, 10.0%		550,000
Secured term loan, due March 31, 2012, LIBOR plus 2.0%		617,300

Total long-term debt		1,187,470
Less current portion		6,500

Total long-term debt, less current portion	$	1,180,970

Debt as of December 31, 2005 consists of the following (in thousands):


Note payable, due December 31, 2014 (913.6 million yen)	$	7,746
Senior unsecured subordinated notes, due June 1, 2012, 10.0%		550,000
Secured term loan, due March 31, 2012, LIBOR plus 2.0%		654,300

Total long-term debt		1,212,046
Less current portion		—

Total long-term debt, less current portion	$	1,212,046

Note Payable

As part of the UGS PLM Solutions Inc. acquisition, EDS agreed to provide one of the Company’s Japanese subsidiaries with cash loans for any cash taxes incurred by that subsidiary in excess of what income taxes would have normally been incurred had certain Japanese subsidiaries constituted a single corporation. Generally, the loans will be made with respect to such Japanese tax payments due for fiscal periods ending on or before December 31, 2006. Interest on the note payable will only be payable for any amounts outstanding after December 31, 2009.

Debt Covenants

The subordinated notes and the credit facility (secured term loan and revolving line of credit) contain various covenants including limitations on additional indebtedness, capital expenditures, restricted payments, the incurrence of liens, transactions with affiliates and sales of assets. In addition, the credit facility requires the Company to comply with certain financial covenants, including leverage and interest coverage ratios and capital expenditure limitations.

Parent Company Debt

In June 2006, UGS Capital Corp. II issued floating rate senior PIK notes (“senior PIK notes”) in the aggregate principal amount of $300.0 million. Interest on the senior PIK notes accrues and is payable semiannually in arrears on June 1 and December 1 of each year, commencing on December 1, 2006 at a rate per annum equal to LIBOR plus 5.00%. The interest is payable in the form of additional notes, or in cash if so elected. The senior PIK notes mature on June 1, 2011. Neither the Company nor any of its subsidiaries guarantee the senior PIK notes. The senior PIK notes do not limit the Company’s ability to incur additional indebtedness, pay dividends, or make other distributions. Because UGS Capital Corp. II is a holding company with no operations and has only the senior PIK notes and its investment in UGS Holdings, Inc., which wholly owns the Company, future cash flows or assets of the Company through 2011 may be required to service the senior PIK notes upon their maturity.

UGS Corp.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—
(Continued)

Note 8: Income Taxes

The expense (benefit) for income taxes is summarized as follows (in thousands):


	Three months
	ended
	June 30, 2006			June 30, 2005
Current	$	(3,137	)	$	5,683
Deferred		863			(14,308	)

Total	$	(2,274	)	$	(8,625	)


	Six months
	ended
	June 30, 2006			June 30, 2005
Current	$	4,500		$	13,141
Deferred		(17,282	)		(25,740	)

Total	$	(12,782	)	$	(12,599	)

(Loss) income before income taxes includes the following components (in thousands):


	Three months
	ended
	June 30, 2006			June 30, 2005
U.S. loss	$	(4,694	)	$	(7,656	)
Non-U.S. loss		(3,999	)		(22,993	)

Total	$	(8,693	)	$	(30,649	)


	Six months
	ended
	June 30, 2006			June 30, 2005
U.S. loss	$	(23,434	)	$	(29,606	)
Non-U.S. loss		(14,921	)		(13,186	)

Total	$	(38,355	)	$	(42,792	)

The Company is not contractually obligated to pay EDS for its share of any consolidated income tax liabilities while it was a member of the EDS consolidated tax return group. Any consolidated income tax liabilities calculated on a separate return basis as due and payable by the Company were treated as non-cash capital contributions from EDS to the Company. Furthermore, pursuant to the stock purchase agreement between EDS and the Company, all income tax liabilities for all tax periods up to, and including, the period ending May 26, 2004 are the financial responsibility of EDS.

As of May 27, 2004, the Company became a member of and participates in the filing of UGS Capital Corp.’s consolidated U.S. Federal income tax return. The Company accounts for current and deferred income taxes on the “separate return” method. Tax attributes of the Parent Companies of the UGS consolidated tax group utilized by the Company are treated as capital contributions by the Parent Companies to the Company because the Company is not contractually obligated to pay the Parent Companies for its utilization of their tax attributes.

The effective tax rate of UGS Capital Corp. and Subsidiaries is substantially similar to the Company’s effective tax rate.

Note 9: Pension Benefits of Certain Foreign Subsidiaries

UGS Corp.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—
(Continued)

Several of the Company’s foreign subsidiaries have defined benefit pension or termination indemnity plans covering substantially all of their eligible employees that are in place as a result of the applicable local statutes. Benefits under these plans are generally based on years of service and final average compensation levels. These plans are managed in accordance with applicable local statutes and practices. The Company deposits funds for these plans with insurance companies, pension trustees, government-managed accounts, and/or accrues the expense for the unfunded portion of the benefit obligation on its consolidated financial statements. The Company’s practice is to fund the various pension or termination indemnity plans in amounts sufficient to meet the minimum requirements as established by applicable local governmental oversight and taxing authorities. Depending on the design of the plan, local custom and market circumstances, the liabilities of a plan may exceed qualified plan assets.

The following table provides the components of net periodic benefit cost recognized in the statement of operations for the six months ended June 30, 2006 and 2005 (in thousands):


	Six months
	ended
	June 30, 2006			June 30, 2005
Service cost	$	1,986		$	1,382
Interest cost		607			423
Expected return on plan assets		(119	)		(112	)
Amortization of prior service cost		69			—
Amortization of net actuarial loss		26			28

Net periodic benefit cost	$	2,569		$	1,721

Note 10: Segment Information

The Company aggregates its operations by geographic location for management reporting purposes. Reportable segments consist of the Americas, Europe and Asia Pacific. The Company’s business involves operations in principally one industry segment: providing PLM software and services to various industries.

Management uses several metrics to measure the performance of each segment, including revenue and operating income. These results are used, in part, to evaluate the performance of, and allocate resources to, each of the segments. Certain operating expenses, which are separately managed at the corporate level, are not allocated to the reportable segments. Unallocated costs include research and development costs, amortization of capitalized software and intangible assets, and corporate general and administrative costs. Accounts receivable is the only significant asset managed at a segment level. All other assets are managed on a consolidated basis. Financial information for each reportable segment is as follows (in thousands):


Revenue	Americas		Europe		Asia Pacific		Total
Three months ended June 30, 2006
License	$	30,992	$	31,262	$	23,763	$	86,017
Maintenance		56,658		52,222		26,262		135,142
Services and other		38,862		29,919		6,719		75,500

Total revenue	$	126,512	$	113,403	$	56,744	$	296,659


Three months ended June 30, 2005
License	$	30,891	$	31,106	$	19,780	$	81,777
Maintenance		54,001		50,173		24,127		128,301
Services and other		40,468		28,486		5,978		74,932

Total revenue	$	125,360	$	109,765	$	49,885	$	285,010


Revenue	Americas		Europe		Asia Pacific		Total
Six months ended June 30, 2006
License	$	62,128	$	59,605	$	43,794	$	165,527

UGS Corp.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—
(Continued)


Maintenance		111,895		96,210		52,726		260,831
Services and other		73,793		56,901		13,401		144,095

Total revenue	$	247,816	$	212,716	$	109,921	$	570,453


Six months ended June 30, 2005
License	$	56,169	$	57,565	$	41,162	$	154,896
Maintenance		101,890		91,298		46,720		239,908
Services and other		76,462		53,698		12,611		142,771

Total revenue	$	234,521	$	202,561	$	100,493	$	537,575


Operating Income	Americas		Europe		Asia Pacific		Total
Three months ended June 30, 2006	$	59,265	$	49,752	$	32,547	$	141,564

Three months ended June 30, 2005	$	55,634	$	43,463	$	23,850	$	122,947


Operating Income	Americas		Europe		Asia Pacific		Total
Six months ended June 30, 2006	$	114,560	$	89,405	$	62,781	$	266,746

Six months ended June 30, 2005	$	101,170	$	81,873	$	52,506	$	235,547


Accounts Receivable	Americas		Europe		Asia Pacific		Total
As of June 30, 2006	$	88,771	$	117,027	$	52,847	$	258,645

As of December 31, 2005	$	86,726	$	114,228	$	50,809	$	251,763

A reconciliation of operating income for reportable segments to operating income is as follows (in thousands):


	Three months
	ended
	June 30, 2006			June 30, 2005
Total operating income for reportable segments	$	141,564		$	122,947
Research and development		(47,388	)		(38,659	)
In-process research and development		—			(4,100	)
Restructuring		—			(1,774	)
Amortization of capitalized and acquired software and other intangible assets		(46,260	)		(39,777	)
Corporate and unallocated costs		(37,792	)		(35,487	)

Operating income	$	10,124		$	3,150


	Six months
	ended
	June 30, 2006			June 30, 2005
Total operating income for reportable segments	$	266,746		$	235,547
Research and development		(98,613	)		(74,640	)
In-process research and development		—			(4,100	)
Restructuring		535			(1,774	)
Amortization of capitalized and acquired software and other intangible assets		(92,125	)		(73,533	)
Corporate and unallocated costs		(71, 868	)		(64,506	)

Operating income	$	4,675		$	16,994

The following presents information about the Company’s operations in selected geographical regions that represent more than 10% of total revenue (in thousands):

UGS Corp.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—
(Continued)


	Three months
	ended
Total Revenue:	June 30, 2006		June 30, 2005
United States	$	116,703	$	117,808
Germany		38,523		36,481
Japan		25,945		24,653
All Other		115,488		106,068

Total	$	296,659	$	285,010


	Six months
	ended
Total Revenue:	June 30, 2006		June 30, 2005
United States	$	230,255	$	220,997
Germany		73,481		64,613
Japan		56,888		54,790
All Other		209,829		197,175

Total	$	570,453	$	537,575

Note 11: Commitments and Contingencies

Legal Proceedings

The Company is not a party to any litigation other than ordinary, routine litigation incidental to its business. In the opinion of management, the ultimate liability, if any, resulting from the aforementioned contingencies will not have a material adverse effect on the Company’s consolidated results of operations or financial position.

Guarantees

The Company adopted the initial recognition and measurement provisions of FASB Interpretation (“FIN”) No. 45, “Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others,” on January 1, 2003, which provisions apply on a prospective basis to guarantees issued or modified after December 31, 2002. The Company has adopted the disclosure provisions of FIN No. 45 in the preparation of these financial statements. In the ordinary course of business, the Company is not subject to potential obligations under guarantees that fall within the scope of FIN No. 45 except for standard indemnification and warranty provisions that are contained within many of its software license agreements, and these give rise only to the disclosure requirements prescribed by FIN No. 45. In addition, under previously existing accounting principles, the Company continues to monitor the conditions that are subject to the guarantees and indemnifications to identify whether it is probable that a loss has occurred, and will recognize any such losses under the guarantees and indemnifications when those losses are estimable. The Company incurred no significant losses related to such indemnifications or guarantees during the periods presented in the accompanying unaudited condensed consolidated Statements of Operations.

Other

In October 2005, one of the Company’s customers filed a voluntary petition for business reorganization under Chapter 11 of the U.S. Bankruptcy Code. As of the date of the petition, accounts receivable from this customer approximated $1.2 million, with virtually all relating to services and maintenance contracts. For the six months ended June 30, 2006, the Company recorded $0.4 million of bad debt expense upon an assessment of the collectibility of the receivable. In April 2006, the Company sold the receivable and received the remaining $0.8 million outstanding.

UGS Corp.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—
(Continued)

During the 90 days prior to the bankruptcy filing, the Company received payments from this customer aggregating approximately $2.7 million, with a total of $2.6 million relating to services and maintenance contracts. Since the payments were made within 90 days of the bankruptcy filing, it is possible that the trustee or debtor in possession in the bankruptcy may seek to avoid the payment as a preference. In the event such a claim was brought, the Company would contest such claim vigorously, and the Company believes it is probable that it would prevail. However, given the uncertainties inherent in bankruptcy proceedings, there can be no assurance that the ultimate outcome would be in the Company’s favor. The Company currently does not believe that it will suffer losses associated with these payments as a result of the filing of this bankruptcy petition. The Company will assess its position on an ongoing basis as the bankruptcy proceeding progresses.

Note 12: Comprehensive Loss

The following table presents the calculation of comprehensive loss (in thousands):


	Three months
	ended
	June 30, 2006			June 30, 2005
Net loss	$	(6,419	)	$	(22,024	)
Currency translation adjustments, net of taxes		8,479			(15,309	)
Change in fair value of derivative instruments, net of taxes		(4,603	)		1,819

Comprehensive loss	$	(2,543	)	$	(35,514	)


	Six months
	ended
	June 30, 2006			June 30, 2005
Net loss	$	(25,573	)	$	(30,193	)
Currency translation adjustments, net of taxes		13,879			(21,531	)
Change in fair value of derivative instruments, net of taxes		(3,688	)		622

Comprehensive loss	$	(15,382	)	$	(51,102	)

Note 13: Related Party Transactions

During the three months ended June 30, 2006, UGS Capital Corp. II issued $300.0 million senior PIK notes. Approximately $3.8 million of the proceeds from the issuance of the notes was used to make a capital contribution to UGS Holdings, Inc. UGS Holdings, Inc. used the capital contribution to make compensatory payments to certain managers of UGS Corp., which were recorded as compensation expense in the statement of operations. The contribution from UGS Holdings, Inc. is reflected as a financing inflow in the statement of cash flows.

Included in accounts payable of the Company is a payable due to its parent, UGS Holdings Inc. of approximately $1.8 million at June 30, 2006. The amount relates to cash received by the Company from UGS Holdings Inc., which received cash from UGS Capital Corp. II for debt costs from the issuance of the floating rate senior PIK notes. The Company expects to pay these costs by the end of 2006.

Note 14: Recent Accounting Pronouncements

In June 2006, the FASB issued FASB Interpretation No. (“FIN”) 48 “Accounting for Uncertainty in Income Taxes – an interpretation of FASB Statement No. 109.” FIN 48 prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. FIN 48 also provides guidance on accounting for derecognition, interest, penalties, accounting in interim periods, disclosure and classification of matters related to uncertainty in income taxes, and transitional requirements upon adoption of FIN 48. FIN 48 is effective for

UGS Corp.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—
(Continued)

fiscal years beginning after December 15, 2006. The Company is evaluating the effect that adoption of this interpretation will have on the Company’s consolidated financial position and results of operations.

In June 2006, the Emerging Issues Task Force (“EITF”) ratified EITF Issue 06-3, “How Taxes Collected From Customers and Remitted to Governmental Authorities Should Be Presented in the Income Statement (That Is, Gross versus Net Presentation).” A consensus was reached that entities may adopt a policy of presenting taxes in the statement of operations on either a gross or net basis. An entity should disclose its policy of presenting taxes and the amount of any taxes presented on a gross basis should be disclosed, if significant. The guidance is effective for periods beginning after December 15, 2006. The impact of EITF 06-3 on the Company’s consolidated financial position or statement of operations will be immaterial.

Note 15: Financial Statements of Guarantors

The Company’s senior unsecured subordinated notes and the obligations under the Company’s senior secured credit facility are guaranteed by certain wholly owned subsidiaries. The guarantees are full, unconditional and joint and several. The following unaudited condensed consolidating schedules of operations, balance sheets and cash flows are presented for the parent company (UGS Corp.), the guarantor subsidiaries, the non-guarantor subsidiaries and the total consolidated UGS Corp.

UGS Corp.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—
(Continued)

SUPPLEMENTAL UNAUDITED CONDENSED CONSOLIDATING
SCHEDULE OF OPERATIONS
(in thousands)


	Three months ended June 30, 2006
	Parent			Guarantor		Non-Guarantor
	Company			Subsidiaries		Subsidiaries			Eliminations			Consolidated
Revenue:
License	$	22,795		$	418	$	62,804		$	—		$	86,017
Maintenance		49,870			116		85,156			—			135,142
Services and other		35,915			58,733		39,478			(58,626)	(a)		75,500

Total revenue		108,580			59,267		187,438			(58,626	)		296,659


Cost of revenue:
License		(150	)		30		2,295			—			2,175
Maintenance		5,423			6		10,266			—			15,695
Services and other		25,025			—		90,768			(58,626	) (a)		57,167
Amortization of capitalized software and acquired intangible assets		17,844			14,010		5,859			—			37,713

Total cost of revenue		48,142			14,046		109,188			(58,626	)		112,750

Gross profit		60,438			45,221		78,250			—			183,909

Operating expenses:
Selling, general and adminstrative		56,421			1,442		59,987			—			117,850
Research and development		47,388			—		—			—			47,388
Amortization of other intangibles assets		2,512			—		6,035			—			8,547

Total operating expenses		106,321			1,442		66,022			—			173,785

Operating (loss) income		(45,883	)		43,779		12,228			—			10,124
Interest expense and amortization of deferred financing fees		(25,686	)		10,231		(11,065	)		—			(26,520	)
Other (expense) income, net		28			8,261		(586	)		—			7,703

(Loss) income before income taxes		(71,541	)		62,271		577			—			(8,693	)
(Benefit) provision for income taxes		(24,271	)		21,795		202			—			(2,274	)

Net (loss) income	$	(47,270	)	$	40,476	$	375		$	—		$	(6,419	)


(a)		- Elimination represents statutory royalty revenue to guarantor subsidiaries and statutory royalty expense to non-guarantor subsidiaries.

UGS Corp.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—
(Continued)

SUPPLEMENTAL UNAUDITED CONDENSED CONSOLIDATING
SCHEDULE OF OPERATIONS
(in thousands)


	Three months ended June 30, 2005
	Parent			Guarantor			Non-Guarantor
	Company			Subsidiaries			Subsidiaries			Eliminations			Consolidated
Revenue:
License	$	25,920		$	140		$	55,717		$	—		$	81,777
Maintenance		48,283			109			79,909			—			128,301
Services and other		37,904			44,839			36,964			(44,775	)(a)		74,932

Total revenue		112,107			45,088			172,590			(44,775	)		285,010


Cost of revenue:
License		1,801			50			4,093			—			5,944
Maintenance		5,493			12			8,990			—			14,495
Services and other		28,096			26			83,354			(44,775	)(a)		66,701
Amortization of capitalized software and acquired intangible assets		11,329			14,010			5,699			—			31,038

Total cost of revenue		46,719			14,098			102,136			(44,775	)		118,178

Gross profit		65,388			30,990			70,454			—			166,832

Operating expenses:
Selling, general and adminstrative		49,158			629			60,623			—			110,410
Research and development		38,659			—			—			—			38,659
In-process research and development		—			—			4,100			—			4,100
Restructuring		—			—			1,774			—			1,774
Amortization of other intangibles assets		2,623			—			6,116			—			8,739

Total operating expenses		90,440			629			72,613			—			163,682

Operating (loss) income		(25,052	)		30,361			(2,159	)		—			3,150
Interest expense and amortization of deferred financing fees		(24,202	)		12,416			(13,430	)		—			(25,216	)
Other income (expense), net		1,490			(9,389	)		(684	)		—			(8,583	)

(Loss) income before income taxes		(47,764	)		33,388			(16,273	)		—			(30,649	)
Provision (benefit) for income taxes		(14,615	)		11,686			(5,696	)		—			(8,625	)

Net (loss) income	$	(33,149	)	$	21,702		$	(10,577	)	$	—		$	(22,024	)


(a)		- Elimination represents statutory royalty revenue to guarantor subsidiaries and statutory royalty expense to non-guarantor subsidiaries.

UGS Corp.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—
(Continued)

SUPPLEMENTAL UNAUDITED CONDENSED CONSOLIDATING
SCHEDULE OF OPERATIONS
(in thousands)


	Six months ended June 30, 2006
	Parent			Guarantor		Non-Guarantor
	Company			Subsidiaries		Subsidiaries			Eliminations			Consolidated
Revenue:
License	$	48,075		$	822	$	116,630		$	—		$	165,527
Maintenance		99,081			304		161,446			—			260,831
Services and other		68,435			108,109		75,406			(107,855	)(a)		144,095

Total revenue		215,591			109,235		353,482			(107,855	)		570,453


Cost of revenue:
License		710			179		5,210			—			6,099
Maintenance		10,395			55		20,350			—			30,800
Services and other		50,400			—		170,470			(107,855	)(a)		113,015
Amortization of capitalized software and acquired intangible assets		35,145			28,020		11,594			—			74,759

Total cost of revenue		96,650			28,254		207,624			(107,855	)		224,673

Gross profit		118,941			80,981		145,858			—			345,780

Operating expenses:
Selling, general and adminstrative		106,336			2,003		117,322			—			225,661
Research and development		98,613			—		—			—			98,613
Restructuring		—			—		(535	)		—			(535	)
Amortization of other intangibles assets		5,135			—		12,231			—			17,366

Total operating expenses		210,084			2,003		129,018			—			341,105

Operating (loss) income		(91,143	)		78,978		16,840			—			4,675
Interest expense and amortization of deferred financing fees		(53,095	)		22,985		(22,857	)		—			(52,967	)
Other (expense) income, net		(2,455	)		13,557		(1,165	)		—			9,937

(Loss) income before income taxes		(146,693	)		115,520		(7,182	)		—			(38,355	)
(Benefit) provision for income taxes		(50,700	)		40,432		(2,514	)		—			(12,782	)

Net (loss) income	$	(95,993	)	$	75,088	$	(4,668	)	$	—		$	(25,573	)


(a)	-	Elimination represents statutory royalty revenue to guarantor subsidiaries and statutory royalty expense to non-guarantor subsidiaries.

UGS Corp.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—
(Continued)

SUPPLEMENTAL UNAUDITED CONDENSED CONSOLIDATING
SCHEDULE OF OPERATIONS
(in thousands)


	Six months ended June 30, 2005
	Parent			Guarantor			Non-Guarantor
	Company			Subsidiaries			Subsidiaries			Eliminations			Consolidated
Revenue:
License	$	49,721		$	410		$	104,765		$	—		$	154,896
Maintenance		92,394			246			147,268			—			239,908
Services and other		73,021			89,303			69,672			(89,225	)(a)		142,771

Total revenue		215,136			89,959			321,705			(89,225	)		537,575


Cost of revenue:
License		4,050			152			6,198			—			10,400
Maintenance		10,372			42			17,444			—			27,858
Services and other		55,603			26			156,293			(89,225	)(a)		122,697
Amortization of capitalized software and acquired intangible assets		22,170			28,020			7,034			—			57,224

Total cost of revenue		92,195			28,240			186,969			(89,225	)		218,179

Gross profit		122,941			61,719			134,736			—			319,396

Operating expenses:
Selling, general and adminstrative		96,577			1,287			107,715			—			205,579
Research and development		74,640			—			—			—			74,640
In-process research and development		—			—			4,100			—			4,100
Restructuring		—			—			1,774			—			1,774
Amortization of other intangibles assets		5,245			—			11,064			—			16,309

Total operating expenses		176,462			1,287			124,653			—			302,402

Operating (loss) income		(53,521	)		60,432			10,083			—			16,994
Interest expense and amortization of deferred financing fees		(46,215	)		28,997			(29,161	)		—			(46,379	)
Other (expense) income, net		(535	)		(12,711	)		(161	)		—			(13,407	)

(Loss) income before income taxes		(100,271	)		76,718			(19,239	)		—			(42,792	)
Provision (benefit) for income taxes		(32,716	)		26,851			(6,734	)		—			(12,599	)

Net (loss) income	$	(67,555	)	$	49,867		$	(12,505	)	$	—		$	(30,193	)


(a)	-	Elimination represents statutory royalty revenue to guarantor subsidiaries and statutory royalty expense to non-guarantor subsidiaries.

UGS Corp.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—
(Continued)

SUPPLEMENTAL UNAUDITED CONDENSED
CONSOLIDATING BALANCE SHEET
(in thousands)


	June 30, 2006
	Parent			Guarantor		Non-Guarantor
	Company			Subsidiaries		Subsidiaries		Eliminations			Consolidated
Assets:
Current assets Cash and cash equivalents	$	(1,840	)	$	117	$	63,195	$	—		$	61,472
Accounts receivable, net		76,098			642		181,905		—			258,645
Prepaids and other		8,052			—		21,154		—			29,206
Deferred income taxes		17,351			—		—		—			17,351

Total current assets		99,661			759		266,254		—			366,674


Property and equipment, net		19,371			—		12,660		—			32,031
Goodwill		324,151			542,785		549,486		—			1,416,422
Capitalized and acquired software, net		212,481			162,671		59,767		—			434,919
Customer accounts, net		72,231			—		117,864		—			190,095
Other intangible assets, net		42,669			—		81,363		—			124,032
Intercompany balances		—			717,111		—		(717,111	)(b)		—
Other assets		810,092			—		15,071		(788,253	)(a)		36,910

Total assets	$	1,580,656		$	1,423,326	$	1,102,465	$	(1,505,364	)	$	2,601,083


Liabilities and Stockholder’s Equity:
Current liabilities
Accounts payable and accrued liabilities	$	52,335		$	2,845	$	91,309	$	—		$	146,489
Deferred revenue		72,807			329		100,691		—			173,827
Income taxes payable		—			—		9,245		—			9,245
Intercompany balances		341,026			—		376,085		(717,111	) (b)		—
Current portion of long-term debt		6,500			—		—		—			6,500

Total current liabilities		472,668			3,174		577,330		(717,111	)		336,061


Other long-term liabilities		—			19,114		44,656		—			63,770
Deferred income taxes		7,668			56,936		43,102		—			107,706
Long-term debt		1,167,300			—		13,670		—			1,180,970

Total stockholder’s equity		(66,980	)		1,344,102		423,707		(788,253	)(a)		912,576

Total liabilities and stockholder’s equity	$	1,580,656		$	1,423,326	$	1,102,465	$	(1,505,364	)	$	2,601,083


(a)	-	Elimination of investment in guarantor subsidiary.

(b)	-	Elimination of intercompany balances.

UGS Corp.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—
(Continued)

SUPPLEMENTAL UNAUDITED CONDENSED
CONSOLIDATING BALANCE SHEET
(in thousands)


	December 31, 2005
	Parent			Guarantor		Non-Guarantor
	Company			Subsidiaries		Subsidiaries		Eliminations			Consolidated
Assets:
Current assets
Cash and cash equivalents	$	(4,266	)	$	962	$	64,836	$	—		$	61,532
Accounts receivable, net		73,305			1,654		176,804		—			251,763
Prepaids and other		10,111			—		12,278		—			22,389
Deferred income taxes		26,471			—		—		—			26,471

Total current assets		105,621			2,616		253,918		—			362,155


Property and equipment, net		22,721			—		13,924		—			36,645
Goodwill		324,151			542,785		526,536		—			1,393,472
Capitalized and acquired software, net		206,926			190,691		67,377		—			464,994
Customer accounts, net		76,801			—		126,263		—			203,064
Other intangible assets, net		46,327			—		88,938		—			135,265
Intercompany balances		—			614,587		—		(614,587	)(b)		—
Other assets		812,857			—		15,019		(788,253	)(a)		39,623

Total assets	$	1,595,404		$	1,350,679	$	1,091,975	$	(1,402,840	)	$	2,635,218


Liabilities and Stockholder’s Equity:
Current liabilities
Accounts payable and accrued liabilities	$	56,304		$	1,566	$	102,106	$	—		$	159,976
Deferred revenue		59,210			699		73,118		—			133,027
Income taxes payable		—			—		11,895		—			11,895
Intercompany balances		248,246			—		366,341		(614,587	)(b)		—

Total current liabilities		363,760			2,265		553,460		(614,587	)		304,898


Other long-term liabilities		—			6,270		42,241		—			48,511
Deferred income taxes		9,689			66,743		71,008		—			147,440
Long-term debt		1,204,300			—		7,746		—			1,212,046

Total stockholder’s equity		17,655			1,275,401		417,520		(788,253	)(a)		922,323

Total liabilities and stockholder’s equity	$	1,595,404		$	1,350,679	$	1,091,975	$	(1,402,840	)	$	2,635,218


(a)	-	Elimination of investment in guarantor subsidiary.

(b)	-	Elimination of intercompany balances.

UGS Corp.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—
(Continued)

SUPPLEMENTAL UNAUDITED CONDENSED
CONSOLIDATING SCHEDULE OF CASH FLOWS
(in thousands)


	Six months ended June 30, 2006
	Parent			Guarantor			Non-Guarantor
	Company			Subsidiaries			Subsidiaries			Consolidated
Cash flows from operating activities
Net (loss) income	$	(95,993	)	$	75,088		$	(4,668	)	$	(25,573	)
Adjustments to reconcile net (loss) income to net cash (used in) provided by operating activities:
Benefit for deferred income taxes		864			(9,807	)		(8,339	)		(17,282	)
Depreciation and amortization		46,888			28,020			27,818			102,726
Amortization of deferred financing fees		2,765			—			—			2,765
Stock-based compensation		236			—			16			252
Unrealized gain on revaluation of foreign denominated assets and liabilities		—			—			(16,935	)		(16,935	)
Unrealized loss on foreign currency revaluation of derivative instruments		—			7,078			—			7,078
Other		2,576			(22	)		1,109			3,663
Changes in operating assets and liabilities, net of effect of acqusitions:
Accounts receivable		(3,527	)		1,034			5,367			2,874
Prepaids and other		2,059			—			(8,117	)		(6,058	)
Accounts payable and accrued liabilities		(5,772	)		1,279			(17,247	)		(21,740	)
Deferred revenue		13,480			(374	)		20,846			33,952
Income taxes payable		—			—			(7,217	)		(7,217	)
Other long-term liabilities		—			94			2,415			2,509

Total adjustments		59,569			27,302			(284	)		86,587

Net cash (used in) provided by operating activities		(36,424	)		102,390			(4,952	)		61,014


Cash flows from investing activities
Acquired software		(4,000	)		—			—			(4,000	)
Payments for purchases of property and equipment		(2,604	)		—			(1,956	)		(4,560	)
Capitalized software costs		(33,917	)		—			(238	)		(34,155	)
Other		(383	)		—			15			(368	)

Net cash used in investing activities		(40,904	)		—			(2,179	)		(43,083	)


Cash flows from financing activities
Intercompany borrowings (payments)		99,820			(103,235	)		3,415			—
Proceeds from revolver credit line		78,800			—			—			78,800
Payments on revolver credit line		(72,300	)		—			—			(72,300	)
Proceeds from notes payable		—			—			5,951			5,951
Payments on notes payable		—			—			(345	)		(345	)
Payments on bank notes and bonds		(37,000	)		—			—			(37,000	)
Intercompany dividends		6,062			—			(6,062	)		—
Capital contributed by parent (stock options exercised)		553			—			—			553
Capital contributed by parent (compensatory payment)		3,819									3,819

Net cash provided by (used in) financing activities		79,754			(103,235	)		2,959			(20,522	)

Effect of exchange rates on cash and cash equivalents		—			—			2,531			2,531

Net increase (decrease) in cash and cash equivalents		2,426			(845	)		(1,641	)		(60	)
Cash and cash equivalents at beginning of period		(4,266	)		962			64,836			61,532

Cash and cash equivalents at end of period	$	(1,840	)	$	117		$	63,195		$	61,472

UGS Corp.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—
(Continued)

SUPPLEMENTAL UNAUDITED CONDENSED
CONSOLIDATING SCHEDULE OF CASH FLOWS
(in thousands)


	Six months ended June 30, 2005
	Parent			Guarantor			Non-Guarantor
	Company			Subsidiaries			Subsidiaries			Consolidated
Cash flows from operating activities
Net (loss) income	$	(67,555	)	$	49,867		$	(12,505	)	$	(30,193	)
Adjustments to reconcile net (loss) income to net cash (used in) provided by operating activities:
Benefit for deferred income taxes		(9,599	)		(9,807	)		(6,334	)		(25,740	)
Depreciation and amortization		32,881			28,020			20,502			81,403
Amortization of deferred financing fees		2,842			—			—			2,842
In-process research and development		—			—			4,100			4,100
Stock-based compensation		154			—			—			154
Other		588			9			1,642			2,239
Unrealized gain on foreign currency revaluation of derivative instruments		—			(16,965	)		—			(16,965	)
Unrealized loss on revaluation of foreign denominated assets and liabilities		—			—			23,486			23,486
Changes in operating assets and liabilities, net of effect of acqusitions:
Accounts receivable		(90	)		1,671			2,804			4,385
Prepaids and other		(1,354	)		220			(271	)		(1,405	)
Accounts payable and accrued liabilities		3,050			104			(14,048	)		(10,894	)
Deferred revenue		13,180			(529	)		34,331			46,982
Income taxes payable		—			—			54			54
Other long-term liabilities		—			—			(164	)		(164	)

Total adjustments		41,652			2,723			66,102			110,477

Net cash (used in) provided by operating activities		(25,903	)		52,590			53,597			80,284


Cash flows from investing activities
Acquisitions, net of cash acquired		—			—			(218,392	)		(218,392	)
Cash received from prior parent for acquisition related tax matters		14,871			—			—			14,871
Payments for purchases of property and equipment		(3,795	)		—			(2,009	)		(5,804	)
Capitalized software costs		(38,501	)		—			(944	)		(39,445	)
Proceeds from sale of marketable securities		—			—			23,194			23,194
Other		(1,762	)		280			1,420			(62	)

Net cash (used in) provided by investing activities		(29,187	)		280			(196,731	)		(225,638	)


Cash flows from financing activities
Intercompany borrowings (payments)		(126,710	)		(51,519	)		178,229			—
Proceeds from revolver credit line		81,351			—			—			81,351
Payments on revolver credit line		(87,351	)		—			—			(87,351	)
Proceeds from notes payable		—			—			6,802			6,802
Payments on notes payable		—			—			(2,773	)		(2,773	)
Proceeds from bank notes and bonds, net		225,201			—			8,893			234,094
Payments on bank notes and bonds		(36,000	)		—			(33,351	)		(69,351	)
Capital contributed by parent		508			—			—			508

Net cash provided by (used in) financing activities		56,999			(51,519	)		157,800			163,280

Effect of exchange rates on cash and cash equivalents		—			—			(3,252	)		(3,252	)

Net increase in cash and cash equivalents		1,909			1,351			11,414			14,674
Cash and cash equivalents at beginning of period		(1,951	)		251			60,100			58,400

Cash and cash equivalents at end of period	$	(42	)	$	1,602		$	71,514		$	73,074

ITEM 2: MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Statements contained in this Quarterly Report on Form 10-Q that relate to our future performance, including, without limitation, statements with respect to our anticipated results of operations or level of business for fiscal 2006 or any other future period, are forward-looking statements within the meaning of the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. Such statements are based on current expectations only, and are subject to certain risks, uncertainties, and assumptions. Should one or more of these risks or uncertainties materialize, or should underlying assumptions prove incorrect, actual results may vary materially from those anticipated, estimated, or projected. The factors that could cause actual results to materially differ include a failure of the PLM market to develop, loss or downsizing of key customers, highly competitive industry, inability to deliver new and innovative PLM software products and services, substantial, prolonged economic downturn in the markets, potential bankruptcies in the automotive industry, disruptions in international markets ,fluctuations in quarterly results, future terrorist attacks, ability to complete or integrate future acquisitions, changes in pricing models for PLM software products, difficulties in our partner relationships, impact of defects, major design errors or security flaws, loss of the use of facilities or systems, intellectual property rights protection and infringement claims, loss of senior executives or employees, high level of indebtedness, and complexity of assessing adequacy of our provision for income taxes. These risks are described in Item 1A of this Quarterly Report on Form 10-Q under the heading “Risk Factors.” We undertake no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events, or otherwise.

Key Business Metrics

Our business performance is directly impacted by our ability to generate software revenue through the sale of CAx and cPDM licenses to existing and new customers. CAx includes CAD, CAE and CAM applications. cPDM applications manage CAx and other product related data and share and control that data in real-time throughout the customer’s organization and with external suppliers, designers and engineers. In conjunction with our initial license sale, we enter into maintenance contracts to provide telephone support and upgrades and enhancements to the software license on a when and if available basis. We may also sign services contracts to provide technical services as needed by customers in order to successfully install the PLM software in their organization. Following the initial maintenance term, our objective is to subsequently renew maintenance contracts. We actively manage our business with the goal of maximizing research and development and sales and marketing productivity. To that end, we carefully evaluate capital investments in research and development projects and sales and marketing initiatives. The following is a brief description of the major components of our financial performance and how we manage them.

Revenue

We earn revenue from three primary sources: license, maintenance and services. For the six months ended June 30, 2006, license accounted for 29.0% of total revenue, maintenance accounted for 45.7% and services and other accounted for 25.3%. License revenue is generated primarily by the sale of perpetual software licenses and, to a lesser extent, the sale of term-based licenses to existing and new customers, and includes both upfront seat purchases as well as follow-on purchases of additional seats or functionality. License sales are generally accompanied by maintenance contracts, which are priced based on a percentage of the license sale. These maintenance contracts provide for when-and-if available upgrades to our applications and technical support. Lastly, services revenue is primarily driven by license sales and includes technical services such as training and installation to facilitate the efficient implementation and usage of our licenses.

For the six months ended June 30, 2006, approximately 56.2% of our total revenue was generated from CAx applications, while the remaining 43.8% was from cPDM. CAx licenses are usually shared at a single workstation, whereas cPDM licenses are usually specific to each end-user and are typically priced lower.

Cost of Revenue

Our license revenue has high gross margins due to low product costs. Our maintenance revenue has high gross margins due to the fact that it requires limited dedicated resources and costs after the initial sale. Services revenue is labor intensive and usually customer- or industry-specific and consequently entails more direct costs than either license or maintenance revenue. The cost of license revenue includes packaging, distribution and third-party royalties; the cost of maintenance revenue is comprised of help desk and technical support and third-party royalties; and the cost of services revenue consists of labor, labor-related costs for teams of technical specialists and third-party contractors. Cost of revenue also includes amortization of intangible assets for capitalized and acquired capitalized software and maintenance agreements.

Sales and Marketing

In general, we manage our customer relationships through a large, direct sales force organized by geography (the Americas, Europe and Asia Pacific). Additionally, we have sales representatives fully dedicated to serving our major customer accounts across the globe. Our direct sales force, including sales managers, account executives, field sales employees and pre-sales technical support, is trained to sell both CAx and cPDM software and services. Sales costs are comprised of salaries for all sales personnel and variable commissions for the field sales staff. The sales representatives are compensated on a monthly basis for new license and services revenue.

We also offer products through third-party distributors and value-added resellers. Our indirect sales channel consists of a network of distributors and resellers covering several regions, including the Americas, Eastern Europe, the Middle East, South Africa, Japan and South Korea. Solid Edge is primarily marketed and licensed through our indirect sales channels and is part of our mid-market CAx offering.

Our global marketing organization focuses on product level initiatives to increase brand equity. We utilize direct marketing initiatives to generate new leads for our sales force. Marketing costs include salaries, trade shows, conferences, product collateral, sponsorship fees and local seminars.

Research and Development Costs

Research and development expenses include payroll, employee benefits, other labor related costs, facilities, workstations and software costs associated with product development. These costs are expensed as research and development. Once technological feasibility is achieved on a project we capitalize the software development payroll and employee benefits cost until the resulting product is available for general release. Expenses for major projects are carefully evaluated to manage return on investment requirements. We expect that our research and development spending will continue in line with historic levels. We have agreed with one of our major customers that, unless they otherwise consent, we will maintain research and development expenses at or above a minimum percentage of net sales. The required percentage is significantly below the percentage anticipated for the foreseeable future and, accordingly, we do not anticipate any impact from this commitment.

In the comparisons that follow in this section, we define Total Research and Development Costs as the sum of research and development costs, which appears as an expense line item on our consolidated statement of operations, and capitalized software costs. We exclude third-party royalty fees and customer directed research and development, which are included in cost of revenue. The following is a summary of Total Research and Development Costs (in thousands):


	Three months
	ended
	June 30, 2006		June 30, 2005
Research and development costs	$	47,388	$	38,659
Capitalized software costs		18,690		22,056

Total Research and Development Costs	$	66,078	$	60,715


	Six months
	ended
	June 30, 2006		June 30, 2005
Research and development costs	$	98,613	$	74,640
Capitalized software costs		34,155		39,445

Total Research and Development Costs	$	132,768	$	114,085

Factors Affecting our Results of Operations

In making comparisons of our financial performance for the periods presented, it is important to be aware of the following factors that have impacted our stated financial results:

Impact of Acquisitions

The purchase prices of UGS PLM Solutions Inc. and Tecnomatix were allocated based on fair value of the specific tangible and intangible assets and liabilities at the time of the acquisition pursuant to a valuation. The excess of the total purchase price over the value of our assets and liabilities at closing was allocated to goodwill, which is subject to annual impairment testing. The purchase accounting adjustments that had a material impact on our financial position and results of operations include:

Deferred Revenue

Purchase accounting adjustments were recorded to reflect the deferred revenue balance at its fair value. These adjustments have the effect of reducing revenue in periods subsequent to the acquisitions, which result in corresponding reductions in gross profit, operating income and income before income taxes. For the six months ended June 30, 2006, the deferred revenue adjustment related to acquisitions resulted in lower total revenue of $0.4 million. For the six months ended June 30, 2005, the deferred revenue adjustment related to the acquisitions resulted in lower total revenue of $8.1 million.

Amortization of Acquired Intangible Assets

With the acquisition of Tecnomatix in April 2005, $121.4 million was allocated to intangible assets pursuant to a valuation. This has resulted in higher expense in cost of revenue for the amortization of capitalized and acquired software and maintenance agreements and in operating expenses for the amortization of all other intangible assets. The annual amortization is approximately $17.0 million.

Acquisition Related Interest Expense

For the acquisition of Tecnomatix, we increased our term loan borrowings under our senior secured credit facility by $225.0 million. This resulted in higher interest expense in the six months ended June 30, 2006 when compared to the six months ended June 30, 2005.

Critical Accounting Policies and Estimates

Our discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires us to make estimates, assumptions and judgments that affect the reported amounts of assets, liabilities, net sales and expenses and relating disclosure of contingent assets and liabilities. On an on-going basis we evaluate our estimates, including those related to amortization periods, intangible assets and goodwill, income taxes, restructuring activities, litigation, and contingencies. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances, the results of which

form the basis for making judgments about carrying values of assets and liabilities that are not readily apparent from other sources. Our results would be affected if we were to make different estimates under different assumptions or conditions and if the actual results are different than the estimates.

Capitalized Software Development Costs

We account for software development costs in accordance with SFAS No. 86, “Accounting for the Costs of Computer Software to be Sold, Leased or Otherwise Marketed.” Costs related to the development of a software product to be sold are expensed until technological feasibility of a product or product enhancement has been reached. Costs incurred after this point are capitalized on a project-by-project basis. Judgment is required in determining when technological feasibility of a product or product enhancement is established. We evaluate the establishment of technological feasibility based on a detailed program design of the product or product enhancement. When the product or enhancement is available for general release to our customers we cease capitalization and begin amortization, which is calculated on a project-by-project basis as the greater of (1) the ratio that the current product revenue bears to the total of current and anticipated future years’ revenue or (2) the straight-line method over the remaining estimated economic lives of the software products. We generally amortize the software costs of new releases of enhancements over a three year period based upon the estimated future economic life of the enhancement. The carrying values of capitalized costs are evaluated for impairment when events or circumstances indicate that the carrying value of the asset may not be recoverable. The carrying values of capitalized costs are evaluated for impairment on an annual basis. If expected cash flows are insufficient to recover the carrying amount of the asset, then an impairment loss is recognized to state the asset at its net realizable value. We have had no impairments of capitalized software costs.

Revenue Recognition

We generate revenue from new licenses, maintenance contracts for license updates and product support and professional services, which include training, consulting and implementation services. While we recognize revenue in accordance with the American Institute of Certified Public Accountants Statement of Position (“SOP”) 97-2, “Software Revenue Recognition,” as amended by SOP 98-9, “Modification of SOP 97-2, Software Revenue Recognition, with Respect to Certain Transactions,” we exercise judgment and use estimates in connection with the determination of the amount of license, maintenance, and services revenues to be recognized in each accounting period.

We recognize revenue when all of the following are met:

	•		persuasive evidence of an arrangement exists;

	•		delivery has occurred or services have been rendered;

	•		the fee is fixed or determinable; and

	•		collectibility is probable.

Our software is sold primarily through our direct sales force. It is our practice to require that a written order signed by both the customer and us, or a purchase order from those customers that have previously negotiated an end user license arrangement, be received. Our software is also sold through indirect channels by third-party distributors and value-added resellers. Provided all other revenue recognition criteria are met, our indirect software sales are recognized on a sell-through basis, which involves obtaining persuasive evidence of the end user’s order placed with the distributor or reseller or evidence that delivery was made directly to the end user.

We deliver software by both physical and electronic means. Both means of delivery transfer title and risk to the customer. For electronic delivery of the software, delivery is complete when the customer has been provided electronic access to their software. Acceptance provisions included in a software license agreement generally grant customers a right of refund or replacement only if the licensed software does not perform in accordance with its published specifications. Based on our history, the likelihood of non-acceptance in these situations is remote, and we recognize revenue when all other criteria of revenue recognition are met. If the likelihood of nonacceptance is determined to be other than remote, revenue is recognized upon the earlier of receipt of written acceptance or when the acceptance period has lapsed.

We perform a collectibility assessment for each transaction pursuant to the collectibility requirements of our credit policy, which includes consideration of customer creditworthiness and historical payment experience. For contracts that do not meet our collectibility criteria, revenue is recognized when cash is received. At the same time, we assess whether the fees are fixed or determinable. Fees are generally considered fixed or determinable when payment terms are set forth at the contract execution date. We recognize revenue for delivered elements only when the fair value of the undelivered elements is known, uncertainties regarding customer acceptance are resolved, and there are no refund, cancellation, or return rights affecting the revenue recognized for delivered elements.

Our license agreements generally include multiple products and services, or “elements.” For multiple element sales orders, revenue is allocated to the individual elements based on vendor-specific objective evidence of fair value (“VSOE”) of the individual elements. The application of license revenue recognition requires judgment, including the determination of the fair value of the elements and whether a license arrangement includes multiple elements. VSOE of the undelivered elements is determined based on the historical evidence of stand-alone sales of these elements to customers. VSOE does not exist for the license element, therefore, we use the residual method to recognize revenue when a license agreement includes one or more elements to be delivered at a future date and VSOE of all undelivered elements exists. Under the residual method, VSOE of any undelivered elements is deferred and the remaining portion of the arrangement fee is recognized as revenue. If evidence of VSOE of one or more undelivered elements does not exist, the total revenue is deferred and recognized when delivery of those elements occurs or when fair value is established. Changes to the elements in a license arrangement and the ability to identify VSOE for those elements could materially impact the amount of earned and unearned revenue.

We defer revenue associated with payments received from customers for the delivery of future services, where VSOE of undelivered elements in a bundled arrangement does not exist, or if other conditions to revenue recognition have not been met. SOP 97-2 requires the seller of software that includes post contract customer support (maintenance or “PCS”) to establish VSOE of the undelivered element of the contract in order to account separately for the PCS revenue. We determine VSOE by a consistent pricing of PCS and PCS renewals as a percentage of the license fees and by reference to contractual renewals, when the renewal terms are substantive. In those cases where VSOE of PCS is determined by reference to contractual renewals, we consider factors such as whether the period of the initial bundled PCS term is relatively long when compared to the term of the license or whether the PCS renewal rate is significantly below our normal pricing practices. Revenues for PCS are recognized ratably over the maintenance term specified in the contract. In arrangements where VSOE of PCS cannot be determined (for example, a time-based software license with a duration of one year or less), we recognize revenue for the entire arrangement ratably over the PCS term.

Professional services generally are not considered essential to the functionality of the other elements of the arrangement and are accounted for as a separate element. Provided all other revenue recognition criteria are met, our revenues for professional services are generally recognized as the services are performed. If there is a significant uncertainty about the project completion or receipt of payment for the professional services, revenue is deferred until the uncertainty is sufficiently resolved. If we do not have a sufficient basis to measure progress towards completion, revenue is recognized when we receive final acceptance from the customer.

Business Combinations

In accordance with SFAS No. 141, “Business Combinations,” we allocate the purchase price of acquired companies to the tangible and intangible assets acquired, liabilities assumed, as well as in-process research and development based on their estimated fair values. Valuations are performed to assist in determining the fair values of assets acquired and liabilities assumed, which requires management to make significant estimates and assumptions, especially with respect to intangible assets. Management makes estimates of fair value based upon assumptions believed to be reasonable. These estimates are based on historical experience and information obtained from the management of the acquired companies. Critical estimates in valuing certain of the intangible assets include but are not limited to: future expected cash

flows from license sales, maintenance agreements, services contracts, customer contracts and acquired developed technologies and patents; expected costs to develop the in-process research and development into commercially viable products and estimating cash flows from the projects when completed; the acquired company’s brand awareness and market position, as well as assumptions about the period of time the acquired brand will continue to be used in the combined company’s product portfolio; and discount rates.

Other estimates associated with the accounting for acquisitions include restructuring costs. Restructuring costs are primarily comprised of severance costs, costs of vacating duplicate facilities, and contract termination costs. Restructuring costs were accounted for under Emerging Issues Task Force (“EITF”) Issue No. 95-3, “Recognition of Liabilities in Connection with a Purchase Business Combination,” and have been recognized as a liability assumed in the business combination. Restructuring costs are based upon plans that have been committed to by management and are subject to refinement. To estimate restructuring costs accounted for under EITF Issue No. 95-3, management utilized assumptions of future costs to operate and eventually vacate duplicate facilities. Estimated restructuring costs may change as additional information becomes available regarding the assets acquired and liabilities assumed and as management continues its assessment of the pre-merger operations and executes the approved plan. Decreases to the estimates of executing the currently approved plans accounted for under EITF Issue No. 95-3 will be recorded as an adjustment to goodwill while increases to the estimates will be recorded as an adjustment to goodwill within one year of the acquisition date and to the results of operations thereafter.

Recoverability of Goodwill, Acquired Intangible Assets and Long-Lived Assets

We account for goodwill under SFAS No. 142, “Goodwill and Other Intangible Assets,” which requires us to review goodwill for impairment on an annual basis, and between annual tests whenever events or changes in circumstances indicate that the carrying amount may not be recoverable. SFAS No. 142 prescribes a two-phase process for impairment testing of goodwill. The first phase screens for impairment, while the second phase, if necessary, measures the impairment. We perform our annual impairment test at October 1, or more frequently if circumstances indicate the potential for impairment which requires management to rely on a number of factors, including operating results, business plans and anticipated future cash flows. We have had no impairments of goodwill.

We review our long-lived assets and intangible assets with definite useful lives under SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets,” which requires us to review for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability of long-lived assets to be held and used and intangible assets with definite useful lives is measured by a comparison of the carrying amount of an asset to the future undiscounted cash flows expected to be generated by the asset. If such assets are considered to be impaired, the impairment is measured by the amount by which the carrying amount of the assets exceeds the fair value of the assets. Assets to be disposed are reported at the lower of the carrying amount or fair value, less cost to sell. There were no impairment charges in the periods presented.

Income Taxes

Income taxes are accounted for under the asset and liability method. Deferred tax assets and liabilities are recognized for future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to be applied to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. Judgments and estimates are required in assessing the future tax consequences of events that have been recognized on our financial statements or tax returns.

The tax benefits for the three and six months ended June 30, 2006 were determined on the year-to-date method. The Company assessed its forecasted annual tax position for 2006 in relation to income (loss)

before tax and determined that a reliable estimate of the annualized effective tax rate (“ETR”) cannot be made at this time.

Our operations were included in EDS’ consolidated income tax returns in certain countries through May 26, 2004. While we were in EDS’ consolidated income tax return, current and deferred taxes were calculated as if taxes were computed on the “separate return” method. Tax attributes allocated to the Company upon our departure from the EDS consolidated group will be made in accordance with the appropriate provisions of the Internal Revenue Code. Certain of our tax attributes, such as net operating loss and tax credit carryforwards, may be impacted by tax authority audits of EDS. Such tax attributes as presented in our financial statements represent management’s estimate based on information available at the time of the financial statements.

We are not contractually obligated to pay EDS for our share of any consolidated income tax liabilities while part of the EDS consolidated tax return group. Any consolidated income tax liabilities calculated on a separate return basis as due and payable by us were treated as non-cash capital contributions from EDS to us. Furthermore, pursuant to the stock purchase agreement between us and EDS, all income tax liabilities for all tax periods up to, and including, the period ending May 26, 2004 are the financial responsibility of EDS.

Recent Accounting Pronouncements

In June 2006, the EITF ratified EITF Issue 06-3, “How Taxes Collected From Customers and Remitted to Governmental Authorities Should Be Presented in the Income Statement (That Is, Gross versus Net Presentation).” A consensus was reached that entities may adopt a policy of presenting taxes in the statement of operations on either a gross or net basis. An entity should disclose its policy of presenting taxes and the amount of any taxes presented on a gross basis should be disclosed, if significant. The guidance is effective for periods beginning after December 15, 2006. The impact of EITF 06-3 on our consolidated financial position or statement of operations will be immaterial.

Segment Revenue and Operating Income

Our business consists of three primary operating segments based on geographic location: the Americas (which is comprised of North and South America), Europe and Asia Pacific. We use several metrics to measure the performance of each segment, including revenue and operating income. These results are used, in part, to evaluate the performance of, and allocate resources to, each of the segments. Certain operating expenses, which are separately managed at the corporate level, are not allocated to the reportable segments. Unallocated costs not reflected in segment operating income include research and development costs, amortization of capitalized software and intangible assets and corporate general and administrative costs, including finance, human resources, legal and IT.

Geographic Segment Revenue

The following table compares our segment revenue for the periods presented (in thousands):


	Three months
	ended						Percentage
	June 30, 2006		June 30, 2005		Increase		Increase
Americas	$	126,512	$	125,360	$	1,152		0.9	%
Europe		113,403		109,765		3,638		3.3	%
Asia Pacific		56,744		49,885		6,859		13.7	%

Total revenue	$	296,659	$	285,010	$	11,649		4.1	%


	Six months
	ended						Percentage
	June 30, 2006		June 30, 2005		Increase		Increase
Americas	$	247,816	$	234,521	$	13,295		5.7	%
Europe		212,716		202,561		10,155		5.0	%
Asia Pacific		109,921		100,493		9,428		9.4	%

Total revenue	$	570,453	$	537,575	$	32,878		6.1	%

The Americas is our largest segment representing 42.7% of total segment revenue for the three months ended June 30, 2006 and 44.0% for the three months ended June 30, 2005. Total revenue was higher primarily due to increased maintenance revenue of $2.7 million, which was partially offset by a reduction in services revenue in the Americas automotive sector.

Americas represented 43.4% of total segment revenue for the six months ended June 30, 2006 and 43.6% for the six months ended June 30, 2005. Total revenue for the six months ended June 30, 2006 includes $10.0 million more revenue from the addition of Tecnomatix operations, which operated for six months in 2006 as compared to three months in 2005 in the periods presented. Total revenue for the six months ended June 30, 2006 includes increased maintenance revenue of $10.0 million, which was due, in part, to renewals on the existing customer base.

Europe is our second largest segment representing 38.2% of total segment revenue for the three months ended March 31, 2006 and 38.5% of total segment revenue for the three months ended June 30, 2005. The revenue increase was primarily due to higher services revenue from cPDM services projects, which are generally larger in scope than CAx service projects.

Europe represented 37.3% of total segment revenue for the six months ended June 30, 2006 and 37.7% for the six months ended June 30, 2005. Total revenue for the six months ended June 30, 2006 includes $5.4 million more revenue from the addition of Tecnomatix operations, which operated for six months in 2006 as compared to three months in 2005 in the periods presented. Total revenue also benefited from higher services revenue from cPDM service projects, which are generally larger in scope than CAx services projects. However, total revenue for the six months ended June 30, 2006 was negatively impacted by approximately $12.8 million by the decline of the Euro compared to the U.S. Dollar.

Asia Pacific is our third largest segment representing 19.1% of total segment revenue for the three months ended June 30, 2006 and 17.5% for the three months ended June 30, 2005. Total revenue for the three months ended June 30, 2006 benefited from license deals with a higher average deal size. Total revenue also increased due, in part, to renewals of back maintenance contracts that had previously expired.

Asia Pacific represented 19.3% of total segment revenue for the six months ended June 30, 2006 and 18.7% for the six months ended June 30, 2005. Total revenue for the six months ended June 30, 2006 includes $2.1 million more revenue from the addition of Tecnomatix operations, which operated for six months in 2006 as compared to three months in 2005 in the periods presented. Total revenue for the six months ended June 30, 2006 benefited from license deals in the last three months with a higher average deal size. Total revenue also increased due, in part, to maintenance associated with license contracts from prior quarters and to renewals of back maintenance contracts that had previously expired.

Geographic Segment Operating Income

The following table compares our operating income for reportable segments for the periods presented (in thousands):


	Three months
	ended						Percentage
	June 30, 2006		June 30, 2005		Increase		Increase
Americas	$	59,265	$	55,634	$	3,631		6.5	%
Europe		49,752		43,463		6,289		14.5	%
Asia Pacific		32,547		23,850		8,697		36.5	%

Total operating income	$	141,564	$	122,947	$	18,617		15.1	%


	Six months
	ended						Percentage
	June 30, 2006		June 30, 2005		Increase		Increase
Americas	$	114,560	$	101,170	$	13,390		13.2	%
Europe		89,405		81,872		7,533		9.2	%
Asia Pacific		62,781		52,505		10,276		19.6	%

Total operating income	$	266,746	$	235,547	$	31,199		13.2	%

In the Americas, operating margin for the three months ended June 30, 2006 increased to 46.8% from 44.4% reflecting a decrease of $4.1 million in cost of revenue and an increase of $1.1 million in revenue. The decrease in cost of revenue is due, in part, to lower costs for third-party consultants. Operating income for the three months ended June 30, 2005 in the Americas includes a reduction of revenue of $1.6 million resulting from purchase accounting. The Americas represented 41.9% of total segment operating income for the three months ended June 30, 2006 and 45.2% for the three months ended June 30, 2005.

In the Americas, operating margin for the six months ended June 30, 2006 increased to 46.2% from 43.1% reflecting a decrease of $3.6 million in cost of revenue and an increase of $13.3 million in revenue. The improved margin is primarily due to higher license and maintenance revenue, which typically carry a higher margin than services revenue. Operating income for the six months ended June 30, 2005 in the Americas includes a reduction of revenue of $3.7 million resulting from purchase accounting. The Americas represented 42.9% of total segment operating income for the six months ended June 30, 2006 and 43.0% for the six months ended June 30, 2005.

In Europe, operating margin for the three months ended June 30, 2006 increased to 43.9% from 39.6% for the three months ended June 30, 2005. The margin increase was due, in part, to an increase in maintenance revenue, which typically carries a higher margin than services revenue. Operating income for the three months ended June 30, 2005 in Europe includes a reduction of revenue of $1.5 million resulting from purchase accounting. Europe represented 35.1% of total segment operating income for the three months ended June 30, 2006 and 35.4% for the three months ended June 30, 2005.

In Europe, operating margin for the six months ended June 30, 2006 increased to 42.0% from 40.4% for the six months ended June 30, 2005. The margin increase was primarily attributable to an improved services margin, which was partially offset by higher selling costs associated with additions in headcount in the sales organization. As the Europe services revenue increased over the prior year, the services margin improved due to a slower increase in costs due to relatively consistent headcount of services personnel. Operating income for the six months ended June 30, 2005 in Europe includes a reduction of revenue of $3.1 million resulting from purchase accounting. Europe represented 33.5% of total segment operating income for the six months ended June 30, 2006 and 34.7% for the six months ended June 30, 2005.

In Asia Pacific, the increase in total operating income was primarily driven by the higher revenue discussed above. For the three months ended June 30, 2006, operating margin in Asia Pacific increased to 57.4% from 47.8% for the three months ended June 30, 2005. The margin increase was primarily attributable to the increase in license and maintenance revenue, which typically has a higher margin than services revenue. The margin increase was also attributable to a decrease in cost of services revenue as there was a decrease in the use of third-party consultants. Operating income for the three months ended June 30, 2005 in Asia Pacific includes a reduction of revenue of $0.4 million resulting from purchase accounting. Asia Pacific represented 23.0% of total segment operating income for the three months ended June 30, 2006 and 19.4% for the three months ended June 30, 2005.

In Asia Pacific, the increase in total operating income was primarily driven by the higher revenue discussed above. For the six months ended June 30, 2006, operating margin in Asia Pacific increased to 57.1% from 52.2% for the six months ended June 30, 2005. The margin increase was primarily attributable to the increase in license and maintenance revenue, which typically has a higher margin than services revenue. Operating income for the six months ended June 30, 2005 in Asia Pacific includes a reduction of revenue of $1.3 million resulting from purchase accounting. Asia Pacific represented 23.6% of total segment operating income for the six months ended June 30, 2006 and 22.3% for the six months ended June 30, 2005.

A reconciliation of operating income for reportable segments to operating income is as follows (in thousands):


	Three months
	ended
	June 30, 2006			June 30, 2005
Total operating income for reportable segments	$	141,564		$	122,947
Research and development		(47,388	)		(38,659	)
In-process research and development		—			(4,100	)
Restructuring		—			(1,774	)
Amortization of capitalized and acquired software and other intangible assets		(46,260	)		(39,777	)
Corporate and unallocated costs		(37,792	)		(35,487	)

Operating income	$	10,124		$	3,150


	Six months
	ended
	June 30, 2006			June 30, 2005
Total operating income for reportable segments	$	266,746		$	235,547
Research and development		(98,613	)		(74,640	)
In-process research and development		—			(4,100	)
Restructuring		535			(1,774	)
Amortization of capitalized and acquired software and other intangible assets		(92,125	)		(73,533	)
Corporate and unallocated costs		(71,868	)		(64,506	)

Operating income	$	4,675		$	16,994

Results of Operations

The following tables set forth information regarding our revenue, operating expenses, net loss and other information for the periods indicated (in thousands):


	Three months ended
	June 30, 2006						June 30, 2005
				(percentage of total revenue)						(percentage of total revenue)
Revenue:
License	$	86,017			28.9	%	$	81,777			28.7	%
Maintenance		135,142			45.6	%		128,301			45.0	%
Services and other (a)		75,500			25.5	%		74,932			26.3	%

Total revenue		296,659			100.0	%		285,010			100.0	%

Cost of revenue (includes amortization of capitalized and acquired software)		112,750			38.0	%		118,178			41.5	%

Gross profit		183,909			62.0	%		166,832			58.5	%


Operating expenses:
Selling, general and administrative		117,850			39.7	%		110,410			38.7	%
Research and development		47,388			16.0	%		38,659			13.6	%
In-process research and development		—			0.0	%		4,100			1.4	%
Restructuring		—			0.0	%		1,774			0.6	%
Amortization of other intangible assets		8,547			2.9	%		8,739			3.1	%

Total operating expenses		173,785			58.6	%		163,682			57.4	%

Operating income		10,124			3.4	%		3,150			1.1	%
Interest expense and amortization of deferred financing fees		(26,520	)		-8.9	%		(25,216	)		-8.8	%
Other income (expense), net		7,703			2.6	%		(8,583	)		-3.0	%

Loss before taxes		(8,693	)		-2.9	%		(30,649	)		-10.7	%
Benefit for income taxes		(2,274	)		-0.8	%		(8,625	)		-3.0	%

Net loss	$	(6,419	)		-2.1	%	$	(22,024	)		-7.7	%


(a)		Other revenue consists primarily of hardware sales.


	Six months ended
	June 30, 2006						June 30, 2005
				(percentage of total revenue)						(percentage of total revenue)
Revenue:
License	$	165,527			29.0	%	$	154,896			28.8	%
Maintenance		260,831			45.7	%		239,908			44.6	%
Services and other (a)		144,095			25.3	%		142,771			26.6	%

Total revenue		570,453			100.0	%		537,575			100.0	%

Cost of revenue (includes amortization of capitalized and acquired software)		224,673			39.4	%		218,179			40.6	%

Gross profit		345,780			60.6	%		319,396			59.4	%


Operating expenses:
Selling, general and administrative		225,661			39.6	%		205,579			38.2	%
Research and development		98,613			17.3	%		74,640			13.9	%
In-Process research and development		—			0.0	%		4,100			0.8	%
Restructuring		(535	)		-0.1	%		1,774			0.3	%
Amortization of other intangible assets		17,366			3.0	%		16,309			3.0	%

Total operating expenses		341,105			59.9	%		302,402			56.2	%

Operating income		4,675			0.8	%		16,994			3.2	%
Interest expense and amortization of deferred financing fees		(52,967	)		-9.3	%		(46,379	)		-8.6	%
Other income (expense), net		9,937			1.7	%		(13,407	)		-2.5	%

Loss before taxes		(38,355	)		-6.8	%		(42,792	)		-7.9	%
Benefit for income taxes		(12,782	)		-2.2	%		(12,599	)		-2.3	%

Net loss	$	(25,573	)		-4.5	%	$	(30,193	)		-5.6	%


(a)		Other revenue consists primarily of hardware sales.

Three Months Ended June 30, 2006 Compared to Three Months Ended June 30, 2005

Total Revenue

The following table compares revenues for the three months ended June 30, 2006 to the three months ended June 30, 2005 (in thousands):


	Three months
	ended
							Percentage
	June 30, 2006		June 30, 2005		Increase		Increase
License	$	86,017	$	81,777	$	4,240		5.2	%
Maintenance		135,142		128,301		6,841		5.3	%
Services and other		75,500		74,932		568		0.8	%

Total revenue	$	296,659	$	285,010	$	11,649		4.1	%

For the three months ended June 30, 2006, revenue increased for all components compared to the same period in 2005. Total revenue reflects a greater increase because of the lower revenue for the three months ended June 30, 2005 of $3.4 million due to the purchase accounting adjustment for deferred revenue.

	•		License. License revenue in the 2006 period benefited, in part, from license sales with a higher average deal size in our Asia Pacific segment. License revenue accounted for 28.9% of total revenue for the three months ended June 30, 2006 and 28.7% for the three months ended June 30, 2005.

	•		Maintenance. Maintenance revenue for the three months ended June 30, 2006 was higher for all operating segments. Also, maintenance revenue reflects a greater increase because of the purchase accounting adjustment described above. Maintenance revenue accounted for 45.6% of total revenue for the three months ended June 30, 2006 and 45.0% for the three months ended June 30, 2005.

	•		Services and other. Services revenue was higher in our Europe and Asia Pacific segments, with Europe having the largest increase due to cPDM services projects, which are generally larger in scope than CAx service projects. This increase was partially offset by lower services revenue in the Americas automotive sector. Services and other revenue accounted for 25.45% of total revenue for the three months ended June 30, 2006 and 26.3% of total revenue for the three months ended June 30, 2005.

Gross Profit

For the three months ended June 30, 2006, gross profit increased $17.1 million, or 10.3%, to $183.9 million from $166.8 million for the three months ended June 30, 2005. The increase was due, in part, to improved services margins that primarily resulted from a decreased usage of third-party consultants. The increase was also due to lower cost of license revenue due to the reduction of the liability of $2.8 million for the settlement with the Department of Commerce for export compliance issues at the time of acquisition of SDRC. Also, gross profit reflects a greater increase because of the lower gross profit for the three months ended June 30, 2005 of $3.4 million due to the purchase accounting adjustment for deferred revenue. Gross margin for the three months ended June 30, 2006 was 62.0% compared to 58.5% for the three months ended June 30, 2005. The increase in gross margin is attributable to higher margins on license and services discussed above.

Operating Expenses

Selling, General and Administrative

For the three months ended June 30, 2006, selling, general and administrative expenses increased $7.4 million, or 6.7%, to $117.8 million from $110.4 million for the three months ended June 30, 2005. The increase was primarily due to the costs of additional headcount in our sales organization. The increase was also due to increased spending on marketing programs. As a percentage of total revenue, selling, general and administrative expenses increased to 39.7% for the three months ended June 30, 2006 from 38.7% for the three months ended June 30, 2005.

Research and Development

For the three months ended June 30, 2006, research and development expenses increased $8.7 million, or 22.5%, to $47.4 million from $38.7 million for the three months ended June 30, 2005. The increase was primarily due to investments in the Teamcenter product line. As previously discussed, we capitalize software development costs once technological feasibility is established. For the three months ended June 30, 2006, cash outflows for capitalized software costs decreased $3.3 million, or 15.0%, to $18.7 million from $22.0 million for the three months ended June 30, 2005. The increase in research and development expenses and decrease in capitalized software costs was due to development activity resources, from completed projects, being shifted into projects for which technological feasibility has not yet been established.

For the three months ended June 30, 2006, Total Research and Development Expenses, as previously defined, increased $5.4 million, or 8.9%, to $66.1 million from $60.7 million for the three months ended June 30, 2005. This increase was primarily due to continued investments in the Teamcenter product line. For the three months ended June 30, 2006, Total Research and Development Costs as a percent of revenue increased to 22.2% from 21.3% for the three months ended June 30, 2005.

Restructuring

Amortization of Other Intangible Assets

For the three months ended June 30, 2006, amortization of other intangible assets decreased $0.2 million, or 2.3%, to $8.5 million from $8.7 million for the three months ended June 30, 2005.

Operating Income

For the three months ended June 30, 2006, operating income increased $6.9 million, to $10.1 million from $3.2 million for the three months ended June 30, 2005. Operating income increased primarily due to an increase in gross profit described above and offset by an increase in selling, general, and administrative expenses and research and development expenses described above.

Interest Expense and Amortization of Deferred Financing Fees

For the three months ended June 30, 2006, interest expense and amortization of deferred financing fees increased $1.3 million to $26.5 million from $25.2 million for the three months ended June 30, 2005. The increase is a result of an increase in the interest rate on the $617.3 million term loan facility.

Benefit for Income Taxes

For the three months ended June 30, 2006, the benefit for income taxes decreased $6.3 million, or 73.3%, to a benefit of $2.3 million from a benefit of $8.6 million for the three months ended June 30, 2005. The effective tax rate changed from a benefit of 28.1% for the three months ended June 30, 2005 to a benefit of 26.2% for the three months ended June 30, 2006. These changes were primarily the result of a decrease in the loss before taxes from $30.6 million for the three months ended June 30, 2005 to a loss of $8.7 million for the three months ended June 30, 2006 combined with increased valuation allowances in 2006, extraterritorial income exclusion benefit increases in 2006 and a decrease in the write-off of in-process research and development costs when compared to the second quarter of 2005.

Six Months Ended June 30, 2006 Compared to Six Months Ended June 30, 2005

Total Revenue

The following table compares revenues for the six months ended June 30, 2006 to the six months ended June 30, 2005 (in thousands):


	Six months
	ended
							Percentage
	June 30, 2006		June 30, 2005		Increase		Increase
License	$	165,527	$	154,896	$	10,631		6.9	%
Maintenance		260,831		239,908		20,923		8.7	%
Services and other		144,095		142,771		1,324		0.9	%

Total revenue	$	570,453	$	537,575	$	32,878		6.2	%

For the six months ended June 30, 2006 revenue increased for all components compared to the same period in 2005. Tecnomatix results were included beginning April 1, 2005, which resulted in $17.6 million more revenue in the 2006 period. Also, total revenue reflects a greater increase because of the lower revenue for the six months ended June 30, 2005 of $8.1 million due to the purchase accounting adjustment for deferred revenue. These items were partially offset by the negative impact of exchange rates in our Europe segment of approximately $12.8 million for the six months ended June 30, 2006 as a result of the decline of the Euro compared to the U.S. Dollar.

	•		License. License revenue in the 2006 period benefited from the inclusion of Tecnomatix operations for six months, which contributed revenue of $5.6 million more than the prior period. License revenue also benefited from license sales in the last three months with a higher average deal size in our Asia Pacific segment. License revenue accounted for 29.0% of total revenue for the six months ended June 30, 2006 and 28.8% for the six months ended June 30, 2005.

	•		Maintenance. Tecnomatix contributed maintenance revenue of $8.0 million more in the 2006 period than in the 2005 period. Maintenance revenue also benefited from renewals on the existing customer base. Also, maintenance revenue reflects a greater increase because of the purchase accounting adjustment described above. Maintenance revenue accounted for 45.7% of total revenue for the six months ended June 30, 2006 and 44.6% of total revenue for the six months ended June 30, 2005.

	•		Services and other. Services revenue benefited from the addition of Tecnomatix, which contributed revenue $4.0 million more revenue in the 2006 period than in the 2005 period. This increase was primarily offset by a decrease in services revenue in the Americas automotive sector. Services and other revenue accounted for 25.3% of total revenue for the six months ended June 30, 2006 and 26.6% of total revenue for the six months ended June 30, 2005. In addition to the decrease of service revenues in the Americas described above, the decrease in services revenue as a percent of total revenue was also due to the incorporation of Tecnomatix operations, which added a higher proportion of maintenance and license revenue than services revenue.

Gross Profit

For the six months ended June 30, 2006, gross profit increased $26.4 million, or 8.3%, to $345.8 million from $319.4 million for the six months ended June 30, 2005. The increase was due, in part, to improved services margins due to a slower increase in costs due to a relatively consistent headcount of services personnel. Gross profit was also higher due to lower cost of license revenue due to the reduction of the liability of $2.8 million for the settlement with the Department of Commerce for export compliance issues at the time of acquisition of SDRC. Also, gross profit reflects a greater increase because of the lower gross profit for the six months ended June 30, 2005 of $8.1 million due to the purchase accounting adjustment for deferred revenue. Gross margin for the six months ended June 30, 2006 was 60.6% compared to 59.4% for the six months ended June 30, 2005. The increase in gross margin is attributable to an increase in license and services margins discussed above.

Operating Expenses

Selling, General and Administrative

For the six months ended June 30, 2006, selling, general and administrative expenses increased $20.0 million, or 9.7%, to $225.6 million from $205.6 million for the six months ended June 30, 2005. The increase was due, in part, to the costs of additional headcount in our sales organization. The increase was also due to increased spending on marketing staff and programs. As a percentage of total revenue, selling, general and administrative expenses increased to 39.5% for the six months ended June 30, 2006 from 38.2% for the six months ended June 30, 2005.

Research and Development

For the six months ended June 30, 2006, research and development expenses increased $24.0 million, or 32.2%, to $98.6 million from $74.6 million for the six months ended June 30, 2005. The addition of Tecnomatix resulted in expenses of approximately $6.1 million more in the 2006 period than in the 2005 period as Tecnomatix operations were included beginning April 1, 2005. As previously discussed, we capitalize software development costs once technological feasibility is established. For the six months ended June 30, 2006, cash outflows for capitalized software costs decreased $5.3 million, or 13.4%, to $34.2 million from $39.5 million for the six months ended June 30, 2005. The increase in research and development expenses and decrease in capitalized software costs was due to development activity resources, from completed projects, being shifted into projects for which technological feasibility has not yet been established.

For the six months ended June 30, 2006, Total Research and Development Expenses, as previously defined, increased $18.7 million, or 16.4%, to $132.8 million from $114.1 million for the six months ended June 30, 2005. This increase was primarily due to continued investments in the Teamcenter product line and the addition of Tecnomatix described above. For the six months ended June 30, 2006, Total Research and Development Costs as a percent of revenue increased to 23.2% from 21.2% for the six months ended June 30, 2005.

Restructuring

In April 2005, we acquired Tecnomatix and initiated restructuring activities designed to reduce the overall cost structure of the organization. These activities provided for workforce reductions of approximately 140 people across all geographical segments totaling $8.1 million, with approximately $1.8 million recorded as a restructuring expense in the six months ended June 30, 2005. For the six months ended June 30, 2006, the restructuring provision was reduced by $1.2 million due to fewer workforce reductions and lower separation payments to employees than originally estimated. Of the $1.2 million reduction, $0.7 million was recorded to goodwill for the reductions associated with the acquired entity. The remaining $0.5 million related to workforce reductions of the Company and was recorded to restructuring in the statement of operations for the six months ended June 30, 2006. Adjustments recognized correspond to the same financial statement line item in which the original accrual was recorded.

Amortization of Other Intangible Assets

For the six months ended June 30, 2006, amortization of other intangible assets increased $1.1 million, or 6.7%, to $17.4 million from $16.3 million for the six months ended June 30, 2005. The increase in amortization is directly related to the intangibles associated with the acquisition of Tecnomatix.

Operating Income

For the six months ended June 30, 2006, operating income decreased $12.3 million, to $4.7 million from $17.0 million for the six months ended June 30, 2005. Operating income was lower primarily due to the increase in selling, general, and administrative expenses and research and development expenses described above.

Interest Expense and Amortization of Deferred Financing Fees

For the six months ended June 30, 2006, interest expense and amortization of deferred financing fees increased $6.6 million to $53.0 million from $46.4 million for the six months ended June 30, 2005. The increase is directly related to the interest expense associated with the debt incurred for the acquisition of Tecnomatix and an increase in the interest rate on the $617.3 million term loan facility.

Benefit for Income Taxes

For the six months ended June 30, 2006, the benefit for income taxes decreased $0.2 million, or 1.5%, to a benefit of $12.8 million from a benefit of $12.6 million for the six months ended June 30, 2005. The effective tax rate changed from a benefit of 29.4% for the six months ended June 30, 2005 to a benefit of 33.3% for the six months ended June 30, 2006. These changes were primarily the result of enhanced exterritorial income exclusion benefits in 2006, increased valuation allowances in 2006, and a decrease in the write-off of in-process research and development costs when compared to the six months ended June 30, 2005.

Liquidity and Capital Resources

Non-GAAP Measures

EBITDA is presented solely as a supplemental disclosure with respect to liquidity because we believe it provides a key indicator of our ability to met our financial obligations. Further, we have included information concerning EBITDA because we use such information in determining compensation of our management and in our review of the performance of our business. EBITDA as presented herein is not necessarily comparable to similarly titled measures. EBITDA represents net income (loss) before interest expense, income taxes, depreciation and amortization. EBITDA is not a recognized term under generally accepted accounting principles, or GAAP. EBITDA does not represent net income, as that term is defined under GAAP, and should not be considered as an alternative to net income as an indicator of our operating performance. Additionally, EBITDA is not intended to be a measure of free cash flow available for management or discretionary use as such measures do not consider certain cash requirements such as capital expenditures (including capitalized software expense), tax payments and debt service requirements. The following is a reconciliation of our EBITDA to net cash provided by operating activities and net income (loss), the GAAP measures we believe to be most directly comparable to EBITDA (in thousands):


	Six months
	ended
	June 30, 2006			June 30, 2005
Reconciliation of EBITDA to net cash provided by operating activities:
EBITDA	$	117,338		$	84,990
Benefit for deferred income taxes		(17,282	)		(25,740	)
Amortization of deferred financing fees		2,765			2,842
In-process research and development		—			4,100
Stock-based compensation		252			154
Other		3,663			2,239
Unrealized (gain) loss on revaluation of foreign denominated assets and liabilities		(16,935	)		23,486
Unrealized loss (gain) on foreign currency revaluation of derivative instruments		7,078			(16,965	)
Changes in operating assets and liabilities		4,320			38,958
Interest expense		(52,967	)		(46,379	)
Benefit for income taxes		12,782			12,599

Net cash provided by operating activities	$	61,014		$	80,284


Reconciliation of EBITDA to net loss:
EBITDA	$	117,338		$	84,990
Interest expense		(52,967	)		(46,379	)
Benefit for income taxes		12,782			12,599
Depreciation and amortization		(102,726	)		(81,403	)

Net loss	$	(25,573	)	$	(30,193	)

Debt and Commitments

Our primary source of liquidity is cash flow generated from operations and availability under the revolving portion of our senior secured credit facility. As of June 30, 2006, we had approximately $102.9 million of borrowing availability under our revolving loan facility, which takes into consideration $6.5 million of revolver loans, approximately $0.6 million of letters of credit outstanding on that date, and $15.0 million of overdraft lines. Our primary cash requirements have been and are expected to be for debt service, working capital, capital expenditures and research and development.

Our debt structure consists of $550.0 million aggregate principal amount of our senior subordinated notes and our senior secured credit facility, consisting of (i) a $617.3 million term loan facility with a maturity on March 31, 2012, and (ii) a $125.0 million revolving credit facility with a maturity on May 27, 2010.

The senior subordinated notes are 10% notes due June 1, 2012. From time to time prior to June 1, 2007, the Company may, at its option and subject to certain requirements, redeem up to 35% of the notes from the proceeds of certain equity offerings. In addition, the Company may redeem some or all of the notes at any time prior to June 1, 2008 at a price equal to 100.0% of the principal amount plus accrued and unpaid interest, plus a make-whole premium. At any time on or after June 1, 2008, the Company may redeem the notes in whole or in part, at redemption prices of 105.0% in 2008, 102.5% in 2009 and 100.0% in 2010 and thereafter, plus accrued and unpaid interest, if any, to the redemption date. The notes are guaranteed, jointly and severally, on an unsecured senior subordinated basis, by UGS PLM Solutions Asia/Pacific Incorporated, UGS Japanese Holdings, Inc., UGS European Holdings, Inc., UGS Israeli Holdings, Inc., and, as required by the indenture by all of our existing and future subsidiaries that guarantee our indebtedness or indebtedness of other guarantors of the notes. Interest on the notes is payable semi-annually. Financing fees incurred in connection with the subordinated notes were deferred and are included in other assets in the consolidated balance sheet. These fees are being amortized to interest expense over the term of the notes.

The borrowings under our senior secured credit facility bear interest at either a floating base rate or a LIBOR rate, in each case plus an applicable margin. The term loan currently carries an interest rate of

LIBOR plus 2.0%. In addition to paying interest on the outstanding principal under our senior secured credit facility, we pay a commitment fee (calculated in arrears) to the lenders under the revolving credit facility in respect of the unused revolving commitments, currently at a rate equal to 0.50% per annum.

In June 2005, the term loan began to amortize in an amount equal to 1.0% per annum in equal quarterly installments for the first six years, with the remaining 94.0% payable in year seven, in equal quarterly installments. During the six months ended June 30, 2006, we permanently repaid $37.0 million of term loan borrowings, prepaying the mandatory quarterly 1% principal payment through 2011. Subject to certain exceptions as defined in our senior secured credit facility, we are required to make mandatory prepayments of the term loans with the net cash proceeds of specified asset sales or other asset dispositions and issuances of debt securities. Beginning in 2007, we may be required to make mandatory prepayments from our excess cash flow as defined in our credit agreement. The obligations under our senior secured credit facility are guaranteed by UGS Holdings Inc., UGS PLM Solutions Asia/Pacific Incorporated, UGS Japanese Holdings, Inc., UGS European Holdings, Inc. and UGS Israeli Holdings, Inc. and will be guaranteed by all of our existing and future wholly owned domestic subsidiaries (except for unrestricted subsidiaries) and by our parent and will be secured by a perfected security interest in substantially all of our assets and the assets of our direct and indirect restricted domestic subsidiaries that are guarantors, in each case, now owned or later acquired, including a pledge of all of our capital stock, the capital stock of each of our domestic subsidiaries and 65% of the capital stock of some of our foreign subsidiaries that are directly owned by us or one of our restricted domestic subsidiaries.

The subordinated notes and the credit facility contain various covenants including limitations on additional indebtedness, capital expenditures, restricted payments, the incurrence of liens, transactions with affiliates and sales of assets. In addition, the credit facility requires us to comply with certain financial covenants, including leverage and interest coverage ratios and capital expenditure limitations. We were in compliance with all of the covenants of the subordinated notes and the credit facility as of June 30, 2006.

Based on our current and anticipated levels of operations and conditions in our markets and industry, we believe that our cash on hand, cash flow from operations and availability under the revolving credit facility will enable us to meet our working capital, capital expenditure, debt service and other funding requirements for the foreseeable future. However, our ability to fund our working capital needs, research and development activities, debt payments and other obligations, and to comply with the financial covenants under our debt agreements, depends on our future operating performance and cash flow, which are in turn subject to prevailing economic conditions, the level of information technology (“IT”) spending and other factors, many of which are beyond our control. Any sizeable future acquisitions, joint ventures or other similar transactions will likely require additional capital and there can be no assurance that any such capital will be available to us on acceptable terms, if at all.

In June 2006, UGS Capital Corp. II issued senior PIK notes in the aggregate principal amount of $300.0 million. Interest on the senior PIK notes accrues and is payable semiannually in arrears on June 1 and December 1 of each year, commencing on December 1, 2006 at a rate per annum equal to LIBOR plus 5.00%. The interest is payable in the form of additional notes, or in cash if so elected. The senior PIK notes mature on June 1, 2011. Neither we nor any of our subsidiaries guarantee the senior PIK notes. The senior PIK notes do not limit our ability to incur additional indebtedness, pay dividends, or make other distributions. Because UGS Capital Corp. II is a holding company with no operations and has only the senior PIK notes and its investment in UGS Holdings, Inc., which wholly owns us, future cash flows or assets of ours through 2011 may be required to service the senior PIK notes upon their maturity.

Capital Expenditures

Capital expenditures including capitalized software decreased to $38.5 million for the six months ended June 30, 2006 from $45.2 million for the six months ended June 30, 2005. The decrease is primarily due to development activity resources, from completed projects, being shifted into projects for which technological feasibility has not yet been established. We expect to spend approximately $86.0 million in capital expenditures in fiscal 2006.

Historical Cash Flow

Our largest source of operating cash flows is from our customers upon the purchase of license and maintenance services, maintenance renewals and professional services. Our primary uses of cash from operating activities are for personnel and facilities related expenditures. For the six months ended June 30, 2006 cash flows from operating activities decreased by $19.3 million primarily due the effects of foreign exchange rate changes and a larger amount of cash outflows for payables during the six months ended June 30, 2006 than the same period in 2005 due to timing of payments.

For the six months ended June 30, 2006, cash used in investing activities decreased $182.5 million. The change in periods presented is primarily related to $218.4 million used in the acquisition of Tecnomatix during the six months ended June 30, 2005. Cash received from the sale of marketable securities and from EDS for the settlement of certain tax matters related to the acquisition of UGS PLM Solutions Inc. slightly offset the use of cash for the acquisition of Tecnomatix.

The change in cash flows from financing activities compared to the prior period is primarily related to the impact of our debt arrangements incurred during the acquisition of Tecnomatix in April 2005.

Off Balance Sheet Obligations

We do not have any material off balance sheet obligations.

Inflation

Historically, inflation has not had a material effect on our results of operations.

Seasonality

Our quarterly operating results have fluctuated significantly in the past and are likely to fluctuate significantly in the future. We have historically realized, and we expect to continue to realize, higher license revenue in the last two weeks of each fiscal quarter. A large portion of our annual license revenue is typically sold during the month of December, and our license revenue, total revenue, operating income and net income have generally been lower in the first quarter of a given year than in the fourth quarter of the preceding year.

ITEM 3. QUALITATIVE AND QUANTITATIVE DISCLOSURES ABOUT MARKET RISK

Foreign Exchange Risk

We are subject to inherent risks attributed to operating in a global economy. Although a sizeable portion of our revenue and costs are denominated in U.S. Dollars, we are exposed to the impact of exchange rate volatility between the U.S. Dollar and the subsidiaries’ functional currencies, primarily from the Euro and Pound Sterling. A devaluation in either of these currencies could have a negative impact on our operating results and cash flows.

We are exposed to credit loss in the event of non-performance by the counterparty to the derivative financial instruments. We mitigate this risk by entering into agreements directly with a number of major financial institutions that meet our credit standards and that we expect to fully satisfy their contractual obligations. We view derivative financial instruments purely as a risk management tool and, therefore, do not use them for speculative trading purposes.

A portion of our revenue is exposed to changes in foreign exchange rates. From time to time, we employ derivative instruments to hedge this risk. We enter into forward contracts to hedge the foreign currency exposure associated with anticipated intercompany royalties. These hedges are denominated in the

following currencies: Euros, British pounds, Swedish kroners, and Swiss francs. The total forward contract commitment at June 30, 2006 was $68.1 million, with the last forward contract expiring in November 2007.

The foreign currency forward contracts are designated as a cash flow hedge and are expected both at inception and on an ongoing basis to be ‘‘highly effective’’ in achieving offsetting changes in cash flows, as defined by SFAS No. 133, ‘‘Accounting for Derivative Instruments and Hedging Activities.’’ The forward contracts are measured at fair value each reporting period with gains or (losses) deferred in other comprehensive income, until the underlying transaction impacts earnings. Any ineffectiveness of the hedge is recognized immediately into earnings. There was no significant ineffectiveness as of June 30, 2006.

In September 2004, we entered into two cross-currency interest rate swap contracts to hedge the impact of foreign currency fluctuations in interest and principal payments relating to intercompany loans denominated in Euros. As of June 30, 2006, the following contracts were outstanding:


							USD
		Interest			Notional		Exchange
	Expiration	Rate			Value		Rate to € 1
		(in millions)
Pay fixed	December 15, 2014		9.0	%	€	45.3		1.2238
Receive fixed			9.025	%
Pay fixed	December 15, 2016		9.0	%	€	42.5		1.2238
Receive fixed			9.08	%

Both swaps, which have been designated as cash flow hedges, effectively convert the future interest and principal payments on the hedged portion of the intercompany loans from Euros to U.S. Dollars. For the three and six months ended June 30, 2006, there was no hedge ineffectiveness recorded in the statement of operations.

Interest Rate Risk

We are subject to interest rate risk for the variable interest rates on our $617.3 million secured term loan and our $125.0 million revolving credit facility. Assuming the revolving credit facility is fully drawn, each quarter point change in our variable interest rate debt would result in a $1.9 million change in annual interest expense.

ITEM 4. CONTROLS AND PROCEDURES

Evaluation of Disclosure Controls and Procedures

We carried out an evaluation, under the supervision and with the participation of our management, including our President and Chief Executive Officer and our Chief Financial Officer, of the effectiveness of the design and operation of our disclosure control and procedures pursuant to Rule 13a-15 under the Securities Exchange Act of 1934, as amended, as of the end of the period covered by this quarterly report. Based upon this evaluation, our President and Chief Executive Officer and our Chief Financial Officer concluded that our disclosure controls and procedures were effective.

During the period covered by this report, there were no changes in our internal controls over financial reporting (as such term is defined in Rules 13a-15(f) and 15d-15(f) under the Securities Exchange Act of 1934, as amended) that have materially affected, or are reasonably likely to materially affect, our internal controls over financial reporting.

PART II — OTHER INFORMATION

ITEM 1A: RISK FACTORS

In addition to the other information set forth in this form 10-Q and our 2005 Form 10-K, you should carefully consider the risk factors associated with our business set forth below. Any of the following risks could materially and adversely affect our business, financial condition, or results of operations.

If the PLM market does not develop as we anticipate, our revenue will be adversely affected.

The PLM industry consists of both a CAx segment and a cPDM segment. We derive approximately 56.2% of our revenues from our CAx portfolio of software and services and the remainder from the cPDM software and services. The CAx industry is relatively mature and our ability to maintain this important source of revenue is dependent on our ability to continue to expand the functionality of our products, maintain our traditional customer base and expand into new industry sectors and geographies. If we are unable to sustain and grow our CAx business or if the PLM market does not develop as we anticipate, our financial condition and results of operations will be adversely affected.

cPDM is a newer and less well known set of applications than CAx applications. As a result, cPDM may not achieve widespread acceptance or the level of penetration in the marketplace that we anticipate. If this market does not develop as we anticipate, our previous investments will not achieve the rate of return we desire and our financial condition and results of operations will be adversely affected.

The loss or downsizing of key customers would significantly reduce our earnings.

Collectively, our top ten customers accounted for approximately 20.1% of our total revenues in 2005. Our earnings, and our stature in our industry, are highly dependent on our business with these customers. Also, due to the importance of our top customers to our financial performance, we are susceptible to increasing demands by them to lower prices or perform additional services at prices inconsistent with our cost structure. If one of our top ten customers downsizes or otherwise contracts its operations, the customer will likely reduce the amount of software and services it purchases from us. A loss of significant business from, or adverse performance by, any of these customers could be harmful to our results of operations.

Our industry is and will likely remain highly competitive.

Our competitors include generalist PLM software developers that offer broad-range systems, such as Dassault Systèmes S.A. and Parametric Technology Corporation, software developers whose product lines are focused on specific segments of the CAx or cPDM markets, such as Agile Software Corporation, enterprise resource planning, or ERP, software developers, such as SAP AG, and niche software vendors selling CAD products largely through distributors and resellers to smaller manufacturing businesses. Competition in the PLM industry is intense and because the market for cPDM is new and fragmented, we expect competition in that sector to intensify.

In addition, new competitors may enter through adjacent industries or through acquisitions. Some of our competitors are better capitalized than we are, and such entities possess significant resources to develop their capabilities in-house or through acquisitions. If one of our competitors with greater resources began to acquire entities in our industry to expand the breadth of their products and service offerings, we may not be able to compete effectively with the combined enterprise. In addition, Dassault benefits from its strategic relationship with International Business Machines Corporation. If we fail to deliver PLM software products that offer superior functionality and reliability and gain market acceptance, or if our competitors are able to deliver products that are superior to ours, our competitive position would be diminished and we would lose market share in the PLM software industry.

If we are unable to deliver new and innovative PLM software products and services, our revenues will be adversely affected.

Demand in the PLM software industry is influenced by rapid technological changes in computer software. In the past, much of the growth in the PLM software industry has been generated by customer demand for PLM software products and services that take advantage of the latest changes in software, hardware, and networking technologies to deliver new and enhanced features and functionality. For this reason, our ability to generate new sales and increase our revenue is highly dependent on our ability to leverage new technologies to:

	•		enhance and expand our existing PLM software products and services; and

	•		deliver new, high-quality PLM software products and services in a cost-effective and timely manner.

Additionally, technological changes often must be anticipated well in advance in order to develop or acquire new products and services that successfully take advantage of new technologies. We may not always anticipate such technological changes. Even if we anticipate technological changes, we may not have adequate resources or skilled personnel to develop or acquire the necessary technology or we may not be able to successfully integrate an acquired technology into our existing products and platforms. If we are unable to successfully deliver new and innovative PLM software products into the marketplace, our revenue will decline. Also, the nature of the PLM industry requires that we make significant investments each year in new technology. If we do not have adequate resources to continue our historic commitment to developing new technologies, our reputation and position in the marketplace will suffer with a corresponding negative impact on our results of operations and financial condition.

Substantial, prolonged economic downturns in the markets in which we operate could cause our customers to reduce their spending on capital investments, which has in the past and could in the future, negatively affect our results of operations.

The amount customers are willing to invest in acquiring and implementing our software applications and the timing of these investments tends to vary depending on general economic conditions in the markets in which our customers operate. We derive a large portion of our revenue from our current customer base in the automotive and transportation sector and the aerospace and defense sector. An economic downturn in one of these industries, and any of the other industries in which we compete, or in the economy as a whole, would lead to a negative impact on our operations. The global economic downturn beginning around the fourth quarter of 2001 and continuing into the first half of 2003 had a significant impact on software and services budgets in many of the key industries we service, and as a result, from 2001 through the first half of 2003, our total revenues and results of operations declined. Additionally, any substantial and prolonged economic downturn in the markets in which we operate may lead to the renegotiation of contracts with our existing customers on terms less advantageous to us.

Continued levels of financial distress and the potential for future bankruptcies in the automotive industry could materially and adversely affect our revenues and profitability.

A large portion of our revenue is derived from our current customer base in the automotive and transportation sector. The automotive industry has historically been cyclical and U.S. auto manufacturers and their Tier I and II suppliers have experienced a challenging operating environment that has resulted in significant financial distress, including bankruptcies. Such bankruptcies or other financial distress of our customer base in the auto industry may adversely impact our cash flows and the collectibility of our receivables. See Note 11 to our unaudited condensed consolidated financial statements for the three months ended June 30, 2006. A sustained downturn in the automotive industry, either globally or in a particular region, could cause automotive manufacturers to reduce production or cease operations, which could adversely affect our revenues and profitability.

Our international sales constitute a substantial portion of our total sales and could be negatively affected by disruptions in international markets caused by currency exchange rate fluctuations, government actions, international political or economic instability, or other similar events.

Revenue from our non-Americas sales represented approximately 56.6% of our total revenue for the six months ended June 30, 2006. We expect revenue from our non-Americas sales to continue to represent a significant portion of our total revenue. For example, we expect most of the future growth of our CAD sales to be in non-Americas sales. There are risks inherent in doing business internationally, including:

• currency exchange rate fluctuations. Many of our non-U.S. revenues and costs are denominated in non-U.S. currencies. To prepare our combined financial statements we must translate those revenues and costs into U.S. Dollars. In the past, this has affected and may in the future affect the value of profits earned on our international sales. Foreign exchange fluctuations may also distort our results, both positively and negatively. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations;”

• imposition of United States and foreign government controls, such as export license requirements, restrictions on the export of critical technology or other trade restrictions, difficulties in obtaining and enforcing intellectual property rights or changes in regulatory practices, tariffs and taxes;

• the extra difficulties in staffing and managing international operations, such as burdens of compliance with a wide variety of laws and regulations, longer accounts receivable payment cycles and difficulties in receivables collections, and tax inefficiencies in repatriating cash flow from non-U.S. subsidiaries; and

• economic, political or social instability in international markets or an international crisis, such as Avian Flu or SARS, which in 2003 delayed the sales of our software and services into the affected countries in Asia. We cannot predict the impact on our revenue and earnings of similar events that restrict travel and contact with current or potential customers or disrupt our operations.

We expect that our quarterly operating results will fluctuate, which may result in fluctuations in the trading price of our 10% senior subordinated notes.

Our quarterly operating results have fluctuated significantly in the past and are likely to fluctuate significantly in the future. Our highest licensing sales for most quarters occur in the last month of the quarter and for most years occur in the month of December, and our software revenue, total revenue, operating income and net income have this year and generally in the past been lower in the first quarter of a given year than in the fourth quarter of the preceding year. These fluctuations may continue or change because of a variety of factors that affect both our ability to sell our products and the timing of sales of our products. In addition, cPDM products tend to be more enterprise-level sales with longer lead-times. As the percentage of our sales derived from the cPDM segment grows, the volatility of our quarterly revenues could increase.

Future terrorist attacks could lead to decreased capital expenditures on PLM software and services and could negatively affect our business.

After the terrorist attacks of September 11, 2001, we experienced a significant decline in our sales as companies decreased their capital expenditures in response to uncertain economic and political conditions. The decline in capital expenditures in response to these conditions resulting from the terrorist attacks on September 11, 2001 was particularly severe in several of our primary markets including the automotive and transportation and the aerospace and defense industries. Future terrorist attacks could have a similar effect on our sales and could negatively affect our financial condition and results of operations.

We received certain indemnities from EDS that may not adequately protect us from liability against all consequences or aspects of matters we were indemnified against.

As part of our separation with EDS, we obtained indemnities from EDS for certain matters from the time of our separation. However, because certain laws place significant limitations on the enforceability of indemnification and such indemnification may be limited by the continued solvency of EDS, there is no assurance that such indemnification agreements will adequately protect us against liability from all of the consequences of these matters. The occurrence of an event not fully indemnified against, or the failure of EDS to meet its indemnification obligations, could result in substantial losses.

Our ability to complete or integrate future acquisitions may adversely affect our business or financial performance.

Part of our business strategy is to selectively acquire other businesses that will complement our existing business. We are generally unable to predict whether or when any prospective acquisition candidates will become available or the likelihood of a material transaction being completed should any negotiations commence. Our ability to finance acquisitions may be constrained by our high degree of leverage. The senior secured credit facility and the terms of the notes significantly limit our ability to make acquisitions and to incur indebtedness in connection with acquisitions.

Any acquisition involves risks, including integration, conversion, and management of acquired technology, operations, customers, and personnel. The process of integrating acquired companies and operations into our operations may result in unforeseen operating difficulties and may require significant financial resources and management’s time and attention that would otherwise be available for the on-going development or expansion of our existing operations. Moreover, the integration of product platforms in an acquisition, as with our merger with Structural Dynamics Research Corporation, or SDRC, in 2001, could result in customer caution and anxiety which may delay orders from customers or those of our acquisition candidates, or may result in customer defections to our competitors. An acquisition may also lead to a one-time in-process research and development charge and ongoing expenses associated with amortization of goodwill and other purchased intangible assets. In addition, acquisitions outside the United States, such as our acquisition of Tecnomatix Technologies Ltd, in April 2005, may present unique difficulties and increase our exposure to those risks attendant to international operations.

Declining unit prices and increased productivity of PLM software products, or changes in the pricing models for PLM software products, could negatively impact our revenue growth.

The competitive markets in which we compete can put pressure on us to reduce our prices. If our competitors offer deep discounts on certain products in an effort to recapture or gain market share or to sell other products, we may then need to lower prices or offer other favorable terms in order to compete successfully. We expect such pricing pressure to be more pronounced in the non-U.S. emerging markets where we intend to target our future growth. Any such changes would be likely to reduce margins and could adversely affect operating results. If we cannot offset price reductions with a corresponding increase in the number of unit sales or with lower spending, then the reduced software revenues resulting from lower prices would adversely affect our results.

As is common in high-tech industries with rapid technological change, our customers may also require us to continue to add functionality to our seats in order to maintain price. The increased productivity of our PLM software applications may result in our customers requiring fewer software seats. Additionally, changes in the pricing model for PLM software products, such as a change to subscription-based licensing or customer reluctance to renew maintenance services at our current rates, could require us to implement a new pricing model in order to remain competitive. A change in pricing model could require significant resources in order to transition successfully and could reduce our revenue during such a transition.

As a result of our strategy of partnering with other companies for product development, marketing, distribution, and services, our products and business development could be adversely affected if we experience difficulties with our partners.

Our PLM strategy requires fully integrated solutions of PLM products, which are themselves increasingly complex. To implement our PLM strategy, we have chosen to partner with other companies: in product development, to integrate other software components; in marketing, to integrate or offer complementary products made by other software providers; in distribution, to sell our products through sales channels; and in services, to provide adequate support for customers adapting and deploying PLM solutions. We believe that our partnering strategy allows us to reduce costs while achieving broader market coverage. Nevertheless, our broad partnering strategy creates a higher dependency on such partners. Serious difficulties in our relationships with our partners, or an unfavorable change of control of our partners, may adversely impact our products or business development.

Defects, major design errors or security flaws in our products could harm our reputation and expose us to potential liability.

Complex software such as PLM software may contain errors or defects when first introduced or when new versions or enhancements are released. If errors or defects are discovered in our current or future products, we may not be able to correct them in a timely manner, if at all. In our development of new products, we may make a major design error. In addition, certain of our Internet browser-enabled products include security features that are intended to protect the privacy and integrity of customer data. Despite these security features, our products may be vulnerable to break-ins and similar problems caused by Internet users, such as hackers bypassing firewalls and misappropriating confidential information. Such break-ins or other disruptions could jeopardize the security of information stored in and transmitted through the computer systems of our customers. To the extent we suffer adverse publicity relating to design flaws or security breaches, the adoption of our software by prospective clients could be adversely impacted.

Our insurance may not cover the cost of correcting significant errors, defects, design errors or security problems. Some of our software incorporates open source code that is not covered by a warranty. We may need to expend significant capital resources in order to eliminate or work around errors, defects, design flaws or security problems. Any one of these problems in our products may result in the loss of or a delay in market acceptance of our products, the diversion of development resources, damage to our reputation, and increased service and warranty costs. Because these problems in our software could result in significant financial or other damage to our customers, our customers could pursue claims against us.

Although our agreements generally contain provisions designed to limit our exposure as a result of actual or alleged design defects, security failures or errors in our software products, services or application hosting, such provisions may not cover every eventuality or be effective under applicable law. Any claim, regardless of its merits, could entail substantial expense and require the devotion of significant time and attention by key management personnel.

Our facilities and systems are subject to the risk of temporary damage due to system interference, breakdown or physical harm.

Our facilities are computer-based and rely on the proper functioning of complex software and integrated hardware systems. It is not possible to guarantee the uninterrupted operation and security of these systems. For example, the invasion of our computer-based systems by either computer hackers or industrial pirates could interfere with their proper functioning and cause substantial damage, loss of data or delays in on-going research and production activities. Computer viruses, whether deliberately or unintentionally introduced, could also cause similar damage, loss or delays. As many of our systems include advanced or state-of-the-art functionalities, computer “bugs” or design errors could cause malfunctions.

The short- or long-term loss of the use of these facilities and systems could have a material negative impact on our business, results of operations and financial condition.

Our international activities subject us to export requirements, the violation of which could adversely affect us.

We supply our products to many international markets. As part of those activities, we are subject to various legal requirements relating to import and export restrictions such as Export Administration Regulations promulgated by the United States Department of Commerce. To the extent we violate any of these regulations, we could be required to pay fines and penalties that could be material. In addition, although such matters are usually resolved through the imposition of civil penalties, we could be subject to the suspension or revocation of our export privileges and we and our officers could be subject to criminal penalties, any of which could be materially adverse to us.

If we are unable to protect our intellectual property rights, it could negatively affect the value of our brands and products.

We rely on a combination of protections provided by contracts, copyrights, patents, trademarks, and other common law rights, such as trade secret and unfair competition laws, to protect our products from infringement which is critical to our success. There can be no assurance that these protections will be adequate or that our competitors will not independently develop software products or technologies that are substantially equivalent or superior to our technology. Despite our efforts, it may be possible for third-parties to reverse-engineer, otherwise obtain, copy, and use information that we regard as proprietary (including certain portions of our software products and technologies), as a result of our use of open source software, or through rights retained by universities and other development co-sponsors. In addition, the laws of some countries do not protect and enforce our proprietary rights to the same extent as do the laws of the United States. Accordingly, we might not be able to protect our proprietary software products and technologies against unauthorized third-party copying or use, which could negatively affect our competitive position.

Our activities, including product research, development and support, are distributed around the world in several of our foreign subsidiaries and foreign offices. Each country in which such activities take place has its own laws and regulations relating to the creation of intellectual property rights and the ownership and transfer of such rights. In spite of our efforts to ensure our ownership of the intellectual property our employees and agents create, the steps we have taken in the past to ensure our ownership of all intellectual property rights created in foreign jurisdictions may have been, and may in the future continue to be, inadequate to support our ownership of the intellectual property rights they create. The loss of substantial intellectual property rights ownership could adversely affect our business.

Elements of our valuable intellectual property include our collection of trade secrets and trademarks. The steps we have taken in the past occasionally have been, and may in the future continue to be, inadequate to protect our rights and deter misappropriation of our trademarks and trade secrets. We have registered certain trademarks and have other trademark registration applications pending in the United States and foreign jurisdictions. The standards which the United States Patent and Trademark Office and similar agencies in other countries use to register trademarks are not always applied predictably or uniformly and can change. We may be unable to detect the unauthorized use of, or take appropriate steps to enforce, our trademark rights. Effective trademark protection may not be available in every country in which we offer or intend to offer our products and services. Failure to adequately protect our trademark rights could damage or even destroy our brands and impair our ability to compete effectively. Furthermore, defending or enforcing our trademark rights and branding practices could result in the expenditure of significant resources.

Claims that our products infringe the intellectual property rights of others could increase our costs and reduce our sales, which would adversely affect our revenue and operating margins.

Some of our competitors may have been more aggressive than us in applying for or obtaining patent protection for innovative proprietary technologies in both in the United States and abroad. Although we have been issued patents under our patent program and have a number of patent applications pending for

inventions claimed by us, there can be no assurance that in the future patents of third-parties will not preclude us from using a technology in our products or require us to enter into royalty and licensing arrangements on terms that are not favorable to us, or force us to engage in costly infringement litigation, which could result in us paying monetary damages or being forced to redesign our products to avoid any infringement.

Third-parties have claimed and may claim in the future that we have infringed their intellectual property rights. We expect that our software products may increasingly be subject to such claims as the number of products and competitors in our industry segment grows, as we expand our products into new industry segments, and as the functionality of products overlap. Additionally, our license agreements with our customers generally provide that we will defend and indemnify them for claims against them relating to our alleged infringement of the intellectual property rights of third-parties with respect to products that we license. We might have to defend or indemnify our customers to the extent they are subject to these types of claims. Defending any of these claims, with or without merit, could be time-consuming, result in costly litigation, cause product shipment delays, subject our products to an injunction, require a complete or partial redesign of the relevant product, require us to pay monetary damages, require us to enter into royalty or licensing agreements or adversely affect our relationships with our customers. Royalty or licensing agreements, if required, may not be available on terms acceptable to us or at all.

The loss of technology licensed from third-parties on a non-exclusive basis that we integrate in our software could delay implementation of our products or force us to pay higher license fees.

We depend on technology that we license from third-parties on a non-exclusive basis and integrate into our software. Licenses for third-party software that we use in our current products might be terminated or not renewed and we may be unable to license third-party software necessary for such products or products we will develop in the future. We may be unable to renegotiate acceptable third-party license terms to reflect changes in our pricing models. Changes to or the loss of a third-party license could lead to an increase in the costs of licensing, inoperability of our software products or the reduction of software performance. In addition, technology licensed from third-parties may have undetected errors that impair the functionality or prevent the successful integration of our software. As a result of any such changes or losses, we may need to incur additional development costs to ensure continued performance of our products or suffer delays in the licensing of software products until replacement technology, if available, can be obtained and integrated.

If we lose the services of our senior executives or employees who possess specialized market knowledge and technical skills, it could reduce our ability to compete, to manage our operations effectively, or to develop new products and services.

Our ability to implement our business strategy and our future success depend largely on the continued services of our senior executives. Many of our senior executives have extensive experience in our industry and with our business, products and customers. The loss of some or all of our senior executives could negatively affect our ability to develop and pursue our business strategy. Also, we have agreed with one of our major customers to retain certain senior executives and key employees working on its account.

In addition, our future performance depends upon our ability to attract and retain highly qualified engineering, sales, marketing, services and managerial personnel. The loss of the technical knowledge and management expertise of any of these key personnel could result in delays in product development, loss of customers and sales and diversion of management resources, which could materially and adversely affect our operating results.

Despite recent adverse economic trends, competition for executive, managerial and skilled personnel in the software industry remains intense. We expect continued increases in compensation costs in order to attract and retain senior executives, managers and skilled employees, especially if the current economy continues to improve. We might not be able to retain our current personnel or continue to attract and retain

the personnel we require to develop and market new and enhanced products and to market and service our existing products and conduct our operations successfully.

Our level of indebtedness could adversely affect our ability to raise additional capital to fund our operations, limit our ability to react to changes in the economy or our industry and prevent us from meeting our obligations under our senior subordinated notes.

We are highly leveraged. The following chart shows our level of indebtedness and certain other information at June 30, 2006.


(In millions)
Senior secured credit facility	$	617.3
Senior subordinated notes	$	550.0
Revolving credit facility	$	6.5
Other debt	$	13.7


Total debt	$	1,187.5
Stockholders’ equity	$	912.6

Our high degree of leverage could have important consequences, including the following:

• it may limit our ability to obtain additional financing for working capital, capital expenditures, product development, debt service requirements, acquisitions and general corporate or other purposes;

• a substantial portion of our cash flows from operations must be dedicated to the payment of principal and interest on our indebtedness and is not available for other purposes, including our operations, capital expenditures and future business opportunities;

• the debt service requirements of our other indebtedness could make it more difficult for us to make payments on the notes;

• certain of our borrowings, including borrowings under the senior secured credit facility, are at variable rates of interest, exposing us to the risk of increased interest rates;

• it may limit our ability to adjust to changing market conditions and place us at a competitive disadvantage compared to our competitors that have less debt; and

• we may be vulnerable in a downturn in general economic conditions or in our business, or we may be unable to carry out capital spending that is important to our growth.

We may not be able to generate sufficient cash to service all of our indebtedness and be forced to take other actions to satisfy our obligations under our indebtedness, which may not be successful.

Our ability to make scheduled payments or to refinance our debt obligations depends on our financial and operating performance, which is subject to prevailing economic and competitive conditions and to certain financial, business and other factors beyond our control. These factors include:

	•		fluctuations in interest rates;

	•		customer actions increasing competition;

	•		global economic situations;

	•		increased operating costs; and

•

trends in our industry.

We might not be able to maintain a level of cash flows from operating activities sufficient to permit us to pay the principal, premium, if any, and interest on our indebtedness. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Liquidity and Capital Resources.”

If our cash flows and capital resources are insufficient to fund our debt service obligations, we may be forced to reduce or delay capital expenditures, sell assets, seek additional capital or restructure or refinance our indebtedness, including the notes offered hereby. We cannot assure you that we would be able to take any of these actions, that these actions would be successful and permit us to meet our scheduled debt service obligations or that these actions would be permitted under the terms of our existing or future debt agreements including the senior secured credit facility or the 10% senior subordinated notes. In the absence of such operating results and resources, we could face substantial liquidity problems and might be required to dispose of material assets or operations to meet our debt service and other obligations. The senior secured credit facility and the indenture governing the outstanding 10% senior subordinated notes will restrict our ability to dispose of assets and use the proceeds from asset dispositions. We may not be able to consummate those dispositions or to obtain the proceeds which we could realize from the dispositions. These proceeds may not be adequate to meet any debt service obligations then due.

Restrictive covenants may adversely affect us.

The senior secured credit facility and the indenture governing the 10% senior subordinated notes contain various covenants that limit our ability and/or our subsidiaries’ ability to engage in specified types of transactions. These covenants limit our ability to, among other things:

	•		incur, assume or guarantee additional indebtedness;

	•		issue redeemable stock and preferred stock;

	•		repurchase capital stock;

• make other restricted payments including, without limitation, paying dividends, making loans and investments and redeeming debt that is junior in right of payment to the senior subordinated;

	•		sell certain assets;

	•		create liens on certain assets without securing the senior subordinated notes;

	•		merge, consolidate, sell or otherwise dispose of substantially all of our assets;

	•		enter into agreements that restrict dividends from subsidiaries;

	•		enter into certain transactions with our affiliates; and

	•		change our business.

In addition, our senior secured credit facility contains restrictive covenants and requires us to maintain specified financial ratios and satisfy other financial condition tests. Our ability to meet those financial ratios and tests may be affected by events beyond its control, and it might not be able to meet those tests. A failure to comply with any of the covenants in the senior secured credit facility and the indenture governing the 10% senior subordinated notes could result in an event of default under our senior secured credit facility and a cross default under the 10% senior subordinated notes upon an acceleration under our senior secured credit facility. Upon the occurrence of an event of default under the senior secured credit facility, the lenders could elect to declare all amounts outstanding under the senior secured credit facility to be immediately due and payable and terminate all commitments to extend further credit. If we were unable to repay those amounts, the lenders under the senior secured credit facility could proceed

against the collateral granted to them to secure that indebtedness. We have pledged a significant portion of its assets as collateral under the senior secured credit facility. If the lenders under the senior secured credit facility accelerate the repayment of borrowings, we might not have sufficient assets to repay the senior secured credit facility and our other indebtedness.

Our variable rate indebtedness subjects us to interest rate risk, which could cause our debt service obligations to increase significantly.

Certain of our indebtedness, primarily borrowings under our senior secured credit facility, are at variable rates of interest and expose us to interest rate risk. If interest rates increase, our debt service obligations on the variable rate indebtedness would increase even though the amount borrowed remained the same, and our net income and cash flows would decrease.

Our global presence increases the complexity of assessing the adequacy of our provision for income taxes.

We are subject to examination of our income tax returns by the Internal Revenue Service and other domestic and foreign tax authorities. Significant judgment is required in determining our worldwide provision for income taxes. In the ordinary course of our business, there are many transactions and calculations where the ultimate tax determination is uncertain. We regularly assess the likelihood of outcomes resulting from these examinations to determine the adequacy of our provision for income taxes. Any adverse outcome from these examinations may have an adverse effect on our operating results and financial position.

We may incur losses associated with currency fluctuations and may not be able to effectively hedge our exposure.

Our operating results are subject to fluctuations in foreign currency exchange rates. We have two cross currency interest rate swaps to partially hedge our exposure to foreign currency exchange rate fluctuations, primarily the Euro. We regularly review our hedging program and will make adjustments as necessary based on the judgment factors discussed above. Our hedging activities may not offset more than a portion of the adverse financial impact resulting from unfavorable movement in foreign currency exchange rates, which could adversely affect our financial condition or results of operations.

ITEM 6. EXHIBITS

The list of exhibits in the Exhibit Index to this report is incorporated herein by reference.

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized, in the City of Plano, State of Texas, on this 14th day of August, 2006.


		/s/ Douglas E. Barnett

		Douglas E. Barnett
		Senior Vice President and Chief Financial Officer
		(on behalf of the Registrant and as Chief Financial
		Officer)

EXHIBIT INDEX


Exhibit No.		Description
31.1		Certification of President and Chief Executive Officer pursuant to Exchange Act Rules 13a-14(a) and 15d-14(a)

31.2		Certification of Chief Financial Officer pursuant to Exchange Act Rules 13a-14(a) and 15d-14(a)

32.1		Certification of President and Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350

UGS Corp. 10-Q