ABOUT OUR FIRM Software Equity Group is the nation’s leading investment bank and M&A advisory for privately- held software companies, e-businesses and IT service providers. Founded in 1992, our firm has provided advice and representation to hundreds of such firms throughout the United States and Canada, as well as Europe, Pacific-Asia, Africa and Israel. We primarily represent sellers – established, successful companies with revenues of $5 million to $50 million that seek to be acquired at a highly attractive valuation. We also provide M&A advisory services to public companies in search of strategic acquisitions. Software Equity Group is known and respected worldwide by public software company CEOs, CFOs and Corporate Development executives, first tier U.S. venture capital and private equity firms and software entrepreneurs. Software Equity Group’s Quarterly Reports are read by decision makers in twenty-six countries and members of our firm are quoted widely in such leading publications as The Daily Deal, Barrons, Reuters, Mergers & Acquisitions, USA Today, Softletter, Software Success, Software CEO Online and Software Business Magazine. Software Equity Group’s senior bankers have keynoted and spoken at more than one hundred software industry conferences and seminars, including Software Business, SoftExpo, Culpepper, VAR Conference, and the Arizona, Colorado, Chicago, Southern California, Denver, San Diego and Boulder Software Associations. Our clients span virtually every software technology, including e-commerce, data analytics, development tools, call center management, digital rights management, embedded systems, wireless apps, supply chain, ERP, CRM, middleware, CAD, internet infrastructure, as well as some 57 different vertical markets. We know these technologies and these software subsectors intimately, and we track closely software market trends and directions. We also have intimate understanding of software company finances and operations, Though every member of our professional team is an experienced investment banker, several are experienced entrepreneurs, as well with strong operating backgrounds. Our firm is highly strategic when positioning a client in the market, and when structuring transactions, but we’re also process driven. We have a database of software company buyers and software M&A transactions which is second to none, a carefully targeted and aggressive marketing and sales methodology, an extraordinary knowledge of software company finances, operations and valuations, and demonstrated skill at the negotiation table. We are absolutely committed to both client satisfaction and results. Our values are clear and deeply embedded: Every client is highly valued. We listen carefully, talk straight and communicate often. We are committed to exceeding expectations. Integrity and professionalism characterize all that we do. REPORT SUMMARY ECONOMY A key barometer of the health of the U.S. business climate, 2005 capital spending grew 12.7% to $342 billion for S&P 500 companies. After three years of soaring profits, most U.S. public companies had no problem paying cash for these capital purchases. Non-financial companies in the Standard & Poor's 500 reported a combined $634 billion in cash by year- end, up from $352 billion in 2001. It’s the largest cash hoard for these S&P companies relative to their market value in 17 years. IT capital expenditures will lay claim to a significant portion of 2006 capital investments. Security remains the top priority. High-buzz technologies and trends, such as virtualization, software-as-a-service and server/storage virtualization ranked low, with open source software in the spending basement. The analysis also provided the first sign the post-bubble pendulum may be shifting again – this time, from single vendor suites to best-of-breed point solutions, signaling better days for smaller, niche vendors. PUBLIC MARKETS The software sector lagged the broader public market indexes much of the year. Although the financial performance of most public software companies continued to improve, the median enterprise market value of the SEG-100, our composite index of publicly traded software companies, finished 2005 down 2.6% relative to the beginning of the year. Two other key metrics were even more telling: Enterprise Value/EBITDA and Enterprise Value/Earnings declined 29.5% and 10.3%, respectively, from 4Q04 to 4Q05, as investors signaled that improved profitability without noteworthy growth was no longer attractive. We expect investor emphasis on revenue growth to intensify in 2006. Public software companies that continue to grow revenue at lackluster rates should see little if any increase in valuation, even as they continue to improve EBITDA margins. Investor insistence on top line growth will undoubtedly cause many public software companies to be even more acquisitive in 2006, particularly those not able to attain the requisite revenue growth organically. IPO/VENTURE CAPITAL The IPO market, after collapsing in 2001, rebounded in 2004, but couldn’t sustain the momentum. Only a handful of software and internet related companies went public in 2005; of these, seven were in the second half of the year. SSA Global, a provider of enterprise software applications, and Kenexa, a provider of workforce management software, were the lone industry IPOs in 2Q05. Finding its offering under-subscribed, SSA Global reduced the number and price of its shares at the eleventh hour and scratched a $100 million special dividend payment to its controlling stockholders. Kenexta did little better, posting a 0.42% gain on the day of its initial offering. Four other IPO candidates that would have priced in 2005 chose not to, citing unreceptive investors and a highly favorable M&A market. 2005 SOFTWARE INDUSTRY EQUITY REPORT Copyright © 2006 Software Equity Group, L.L.C. Venture capital firms remained cautious and conservative in 2005, allocating more than 80% of invested funds to expansion stage and later stage private companies. Software, once again, continued to lead all other industry sectors in attracting VC investment. MERGERS AND ACQUISTIONS U.S. mergers and acquisitions (M&A) grew in both volume and value during the year. Software represented 15.7% of total M&A deal activity, leading all other industry sectors. The median valuation of software industry M&A transactions in 2005 grew every quarter. For the year, the median software company M&A valuation, measured as a multiple of TTM revenue, beat 2004’s median valuation of 2.4x, and was up sharply from 2003’s 1.6x multiple. Median software M&A valuations continued to vary widely by product category. Sellers with enterprise solutions that required significant but non-essential capital spending, and sellers in yesterday’s high spend categories that have not yielded the anticipated return, lagged well behind less expensive, readily deployable solutions offering measurable, near- term benefits. Not surprisingly, software company sellers in product categories with median revenue growth rates above 12% had significantly greater valuations than product companies in the low revenue growth categories. Product extension deals continued to lead all others, as buyers sought to enhance their current product suite by acquiring small and mid-cap companies targeting the same markets with highly complementary, best-of-breed, market proven products and technology. Looking to 2006, the industry pundits and prognosticators continue to tout the benefits of software as a service (SaaS). By best count, there are some 40,000 privately-held software companies in the United States. We estimate more than 90% have annual revenue of less than $10 million, yet many provide essential and superb point solutions and product suites to the Fortune 1000. Is SaaS their pricing model of the future? Perhaps, but let’s not ignore basic economics. With little cash on hand, and virtually no professional money available to it, where will a private ISV that adopts a SaaS business model find the capital to rewrite its application suite in JAVA or .Net, add major functionality, and deploy on new platforms? Even if the recipe calls for periodic payments amortized over a two or three year initial license term, few bootstrapped private software companies will be able to stay afloat long enough for subscription model cash flows to equal cash flows from paid-up licenses, professional services and M&S. 2005 SOFTWARE INDUSTRY EQUITY REPORT Copyright © 2006 Software Equity Group, L.L.C. CONTENTS U.S. ECONOMY: SOFTWARE INDUSTRY MACROECONOMICS.............................................................1 PUBLIC MARKETS AND PUBLIC SOFTWARE COMPANY PERFORMANCE.............................................2 INITIAL PUBLIC OFFERINGS (IPOS)..................................................................................................5 VENTURE CAPITAL AND PRIVATE EQUITY ........................................................................................8 MERGERS AND ACQUISITIONS: THE NUMBERS...............................................................................11 MERGERS AND ACQUISITIONS: THE DRIVERS ................................................................................16 MERGERS AND ACQUISITIONS: A LOOK AT THE YEAR AHEAD ........................................................19 APPENDIX A: MERGERS AND ACQUISITIONS, MOST ACTIVE BUYERS.............................................21 APPENDIX B: MERGERS AND ACQUISITIONS BY SOFTWARE INDUSTRY CATEGORIES ......................24 - Accounting