GRAPHISOFT SE ANNUAL REPORT 2006 THE LETTER OF THE CHAIRMAN OF THE BOARD AYEAR OF DRAMATIC CHANGES Without question, the year 2006 saw the most sweeping changes in the 24 year history of Graphisoft. Five major events left Graphisoft a very different company at the close of 2006: • moving the seat of the holding company from the Netherlands to Hungary • spinning out the Real Estate Development Business Unit • exploring the challenges of the new Virtual Construction™ business • placing the core business (ArchiCAD) on an aggressive growth path again, • and finally the major shareholders of the Company sold their controlling stake to our main European industry peer, Nemetschek AG. MOVING THE CORPORATE SEAT TO HUNGARY In 1996 CSK, a leading Japanese IT corporation, and Nippon Investment Fund concluded an agreement with Graphisoft to invest USD 7.5 million in the Company. The goal was to list Graphisoft’s shares on one of the major international stock exchanges within 3 years. At that time, however, the international investment community was unfamiliar with the relatively imma- ture Hungarian corporate legislation. To eliminate potential concerns of global technology investors, the original founders and their new Japanese partners registered a new holding com- pany in the Netherlands. Dutch corporate law was regarded by the international investor com- munity as more mature than in Hungary. This holding company became the controlling entity for all Graphisoft Group companies. In 1998, Graphisoft NV successfully introduced its shares on the Neuer Markt, the new technol- ogy oriented section of the Frankfurt Stock Exchange. In 2000 the Company also completed its listing on the Budapest Stock Exchange. As Hungary joined the European Union in 2004, there was no longer any reason not to have its legal seat in Hungary where the Company headquar- ters has operated since its inception in 1982. The adaptation of new legal form "Société Européene" ("SE") allowed more flexibility to operate and move within the European Union. The Company chose this legal corporate form in the tradition of its preference for pioneering solu- tions. Finally, as one of the very first SEs in the Union, Graphisoft SE used this opportunity to relocate its seat. As of 2006, the Company operates as a Budapest, Hungary-based SE. 1 THE LETTER OF THE CHAIRMAN OF THE BOARD SPINNING OUT THE REAL ESTATE DEVELOPMENT BUSINESS Leasing the Company’s temporarily unused office space was a relatively minor side business of the Company in 1998, when it moved into its new facilities at a quiet waterfront location on the Danube in Budapest. In time, however, Graphisoft Park’s exceptional location and high quality standards attracted many other high tech companies, including Microsoft Hungary, SAP Hungary, Canon Hungary and others. As a result, the real estate development/office lease business became a highly profitable venture for Graphisoft. By 2005, the lease revenue grew to €3M with over €1M net income and €24M real estate asset value on historic cost basis. The size of the real estate business made it necessary to have a different source of financing, reporting structure and a clear separation of business and management activity from the core software business. The financial and legal re-organization began in 2005. Graphisoft Park Kft., responsible for the real estate business and owner of most of the real estate, was separated from Graphisoft R&D Zrt. as a wholly owned subsidiary of Graphisoft SE. On April 28th, 2006, the Annual Shareholder’s Meeting of Graphisoft SE decided to de-merge Graphisoft SE’s traditional core software business and its real estate development activity into two independent corporate enti- ties. The software business (Graphisoft SE) continued its operation as the surviving company, while a new and separate company (Graphisoft Park SE) was created as the holder of all real estate related assets, including Graphisoft Park Kft. The surviving Graphisoft SE continued its listing on the Budapest Stock Exchange, while the shares of the new Graphisoft Park SE were distributed among the shareholders of Graphisoft SE, proportionally with their holding in the pred- ecessor company. Following its legal incorporation on August 21, 2006, Graphisoft Park SE also applied for listing on the Budapest Stock Exchange, which was successfully completed on August 28, 2006. The corporate restructuring of Graphisoft was received positively by the investor community. Following the separation the combined value of the two companies exceeded by approximately 30% the average value of the predecessor company in the prior months. Graphisoft SE’s present Annual Report is limited to the presentation of the software business results in 2006 (the first eight-month result of the real estate business is reported as discontin- ued operation), while Graphisoft Park SE provides its own separate Annual Report for 2006 (for the period from August 21 through December 31, 2006). THE CHALLENGES OF VIRTUAL CONSTRUCTION™ In late 2004 the Company launched its new 5D Virtual Construction™ product line targeted at the construction market. 5D (model, schedule & cost) helps customers to optimize project cost and schedule while analyzing designs for constructability issues. The result is a reduction in overall cost and shorter project schedules. The first full year results (2005) exceeded even the most opti- mistic expectations. Utilizing a combination of Graphisoft services and in-house adoption, for- 2 THE LETTER OF THE CHAIRMAN OF THE BOARD ward-looking owners and construction companies such Webcor Builders, Hensel Phelps, Team Limited, Applecross Development , Urban Builders and Rogers Quinn successfully implemented 5D Virtual Construction™ in their daily practice and the product line proved its market viability. In addition to attracting the new and lucrative market of owners and construction companies, 5D Virtual Construction™ helped to improve Graphisoft’s position in its traditional architectural design market. As was the case 20 years ago when Graphisoft pioneered 3D design in architec- ture, we introduced 5D to the world reinforcing our technology trend-setting position in the build- ing industry. Following these initial successes, in 2006 the Company aggressively expanded its R&D and con- struction services resources to capitalize on the new and promising growth opportunity. Although the growth continued in 2006 (+41% revenue), these results were far below the 2006 operating plan. Due to increased operating expenses the loss of the business unit exceeded €7M, even without the one-time extraordinary expenses related to the corporate re-structuring, detailed above. In spite of a relatively large customer base for a two-year old business, it became clear that mov- ing from a few early adopters within each firm to firm-wide adoption would take a very long time in the traditionally conservative construction industry. It became clear during 2006 that the loss- es required to develop this business for an unpredictable number of years would not be in the best interest of Graphisoft shareholders. For this reason, management explored other financing opportunities for Virtual Construction™. On February 12, 2007 the Company announced a pre- liminary agreement with the management of the Construction Division, backed by leading ven- ture firms to spin out this business unit into a new company. Graphisoft will hold only a minority stake in this new venture. We anticipate that continuing this business as an independent com- pany will serve to substantially increase the profit of Graphisoft in 2007 while maintaining the syn- ergy between 3D and 5D, helping us to secure new and larger customers. ARCHICAD ON A NEW AND PROFITABLE GROWTH PATH AGAIN 2006 saw ArchiCAD’s sales grow a robust 25%, faster than the sales of any of the leading com- petitors in the building industry. It is important to look at the drivers of this growth from a historical perspective. Graphisoft’s Virtual Building™ solution has led the 3D model-based architectural design market since 1984 when ArchiCAD was first introduced. In recent years, this market has also become known as Building Information Modelling (BIM). The overwhelming majority of architectural design prac- tices, however, retained their 2D workflow. As a result, Graphisoft’s share of the entire architec- tural design market remained below 10%. The challenge for the Company was not how to grow its share among architects who prefer to design in 3D, but how to move the majority of architects from the 2D drawing automation to 3D model-based design. 3 THE LETTER OF THE CHAIRMAN OF THE BOARD The opportunity began to appear around 2000 when the saturation of the 2D drafting software market forced Graphisoft’s main competitors to look for new market momentum drivers. They started to promote the concept of BIM aggressively. The concept caught on with mainstream users both in terms of mindset and purchasing behavior. According to Gartner Group’s AEC Market Report for October 2006, after several years of market decline, 2005 showed a new growth momentum in the architectural design software market driven by BIM. ArchiCAD sales figures in 2006 added strongly to this momentum. During 2006 the number of new license shipments neared 10,000, while the number of maintenance contracts (clients sub- scribing in advance for regular update) achieved 33,200, 15,200 out of them subscribed in 2006. The growing number of clients on maintenance contract is particularly important. It represents a more predictable revenue stream for the Company and leaves more resources for resellers to work on new prospects, rather than spending too much time selling upgrades to the existing client base. The positive change in market dynamics, strong sales and marketing execution and first and foremost the stability and attractiveness the new ArchiCAD 10 were the key factors behind this success. Moving beyond the activities that drive revenue for the short term, 2006 marked the year that we rolled out our first comprehensive program for universities, students and teachers on a global basis.