The Software Field Guide Volume 3, Number 5 Subscribe at

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1 C. Eugene Munster Senior Research Analyst, Security & Design , Tad W. Piper, CFA Senior Research Analyst, Software Applications , David M. Rudow Senior Research Analyst, Technology Software , Catriona M. Fallon Research Analyst, Software Applications , Scott A. Nicholas, Research Analyst, Security & Design , Michael J. Olson, Research Associate, Security & Design , Jennifer A. Swanson Research Analyst, Technology Software , Reason for Report: Industry Overview This report should be read in conjunction with important disclosure information found at the following site: losures The Software Field Guide Volume 3, Number 5 Subscribe at Industry Note Did you know that the Caesar salad is not named after Julius Caesar? It is named for its creator, Caesar Cardini, who first prepared the salad in his Caesar's Palace Restaurant in Tijuana, Mexico. Did you also know that The Software Field Guide is the best weekly source for information on the world of software? In This Week s The Software Field Guide: I. Infrastructure Software: December Quarter in Review II. Industry News I. Infrastructure Software: December Quarter in Review For the December quarter, the bulk of infrastructure software companies posted modest upside to revenue and EPS expectations, with March quarter guidance generally in line or slightly better than consensus expectations. Integration software showed the greatest outperformance in the quarter, while content management was weaker than other subsectors. Systems Management software companies posted modest upside to revenue and EPS estimates, with March quarter guidance generally in line or slightly better than consensus expectations. However, the market had been hoping for more, and many stocks traded off following solid results and raised guidance. We believe that the bar has been reset, with management teams hoping to break investors of the habit of constantly expecting greater and greater outperformance. Furthermore, we think that improving economic conditions will lessen the absolute value of outperformance or underperformance as management teams gain better visibility into and control over their own businesses and customers feel less pressure to conserve budgets early in the year and panic buy in a budget "flush" at the end of the year before budget dollars disappear. Piper Jaffray & Co. does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that the firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decisions. This report should be read in conjunction with important disclosure information, including an attestation under Regulation Analyst Certification, found at the end this report or at the following site: The Software Field Guide Page 1 of 6

2 Deals >$1M Continue to Grow. BMC closed 33 transactions >$1M, versus 24 last year and 18 in the previous quarter. BMC also closed four deals >$5M, including two >$10M. Mercury saw a "record number" of deals over >$1M: 19 versus the previous record of eight. Quest saw an increase as well, closing five deals >$1M vs. three in the previous quarter and two last year. Mainframe SMS Vendors Posted Solid Results. Vendors employing MIPS-based pricing on mainframe systems showed healthy results in the quarter. BMC, Compuware, and CA all outperformed expectations, with CA commenting that capacity upgrades had been lagging the broader tech market, but the situation was improving and they are optimistic about what they're seeing there. In addition, Compuware commented that pricing pressure from IBM had subsided somewhat in the quarter. Ratable Models Continue to Build Momentum. BMC and Mercury both saw strong growth in ratable bookings in the December quarter, as customers gravitated toward term licenses over perpetual. BMC saw a "record increase" in ratable transactions in the quarter, while Mercury saw ratable bookings grow to a record high of 40% of total bookings. Hiring Returns. BMC saw headcount increase by 119, primarily due to expansion in India; Citrix increased total headcount by 80 in the quarter; and Compuware signaled that it may reverse some of the salary cuts imposed in While hiring remains modest, it is improving, and we believe the increased investment in headcount is a bullish sign for next year. IT Governance Area of Notable Strength. BMC's Remedy business continues to be their best performing division, while Compuware stated that they are looking to make an acquisition in the IT governance space. Mercury's Kintana business showed improvement after a sluggish Q3 and exceeded the original guidance. Application Development and Deployment tools vendors were generally strong in the December quarter, with database management tools showing the greatest strength. Quest reported strong growth across all businesses, including database management tools; Embarcadero posted modest upside to the quarter and strong guidance for Q1; BMC showed 23% y/y growth in enterprise data management license bookings; and IBM saw DB2 database tools grow 20% y/y. Application development was fairly solid as well, with Borland posting upside to Q4 expectations and IBM reporting that its Rational business grew 28% y/y, exceeding internal targets. Improving Climate for DBA Tools. Embarcadero posted strong results for the quarter, and both Quest and BMC cited strength in their respective DBA tools suites. IBM saw healthy y/y growth in database tools as well. Big Deals Returning. Borland saw an uptick in deals >$500K, closing 13 deals over half a million in Q4 versus 10 in Q3 and four in Q402. Embarcadero saw an increase in deals >$100K, to 18 in Q4 from 11 in Q3 and 10 in Q402. Environment Stabilizing, But Execution Still Key. We believe that the economic climate is stabilizing and it is becoming slightly easier to close transactions. However, tight execution remains central to strong results, and companies that fail to closely monitor and manage their pipelines will still be challenged. Enterprise Application Integration vendors outperformed in the December quarter, posting results solidly above expectations. However, guidance was more cautious, which is appropriate since these vendors saw extremely strong December 2002 quarters only to have business evaporate in the March 2003 quarter. This time around, integration vendors are taking a more conservative approach, but we believe that the market conditions are better and guidance should be achievable. Platform Sales Driving Higher ASPs. SeeBeyond saw its average initial deal size grow to $500K in Q4, versus a traditional level of $400K. We believe this increase was a function of customers buying new modules in addition to the core egate The Software Field Guide Page 2 of 6

3 platform. Iona saw an increase in average deal size as well to $75K, up from $50K in Q3. However, webmethods' ASP remained flat at $400K. Largest Deals Remain Elusive. While other areas of software saw an uptick in deals >$1M, integration software vendors saw large deals flat or down from Q3. webmethods closed five deals >$1M in the December quarter versus six in the September quarter, while SeeBeyond closed four deals >$1M, versus four in the September quarter. We believe that while buying has improved, most customers are still resistant to very large deals and are choosing to do small initial deployments with incremental buying after the first implementation, instead of making a large upfront financial commitment. Existing Customers Providing Bulk of Business. webmethods commented that 65% of business in the quarter came from existing customers, while SeeBeyond got 58% of its revenue from existing customers. This is consistent with our belief that customers are doing smaller initial deployments followed by incremental buying as the software is rolled out more broadly. Content Management vendors saw generally in line, but somewhat mixed, results for the December quarter. IBM's content management business saw a "slowdown" in the December quarter, growing only 2% y/y. Stellent and Vignette also reported modest results. However, EMC said that its recently acquired Documentum business performed very well in the quarter, while FileNET and Open Text beat expectations. Consolidation Continues. The December quarter included a flurry of M&A transactions within the content management space including Vignette's pending acquisition of Tower Technology and completed acquisition of Intraspect, Stellent's pending acquisition of Optika, and IBM's acquisition of Green Pasture Software. We also saw the Interwoven/iManage and EMC/Documentum transactions close in the quarter. Sarbanes-Oxley Not Yet Impacting Results. In the September quarter, a number of the content management vendors, including Stellent, imanage (now Interwoven), and Documentum (now EMC), highlighted their solutions to help companies attain compliance with Sarbanes-Oxley litigation as a growth driver for the next three quarters. However, we saw little impact from this in December, and are uncertain whether we will see this benefit in the March quarter. Currency Exchange Rates Less of a Driver. One possible reason why the content management group performed somewhat less than other areas of software infrastructure is that many of the companies listed below have little exposure outside of the United States, hence less benefit from exchange rates. Vignette got 26% of revenue from international, Stellent got 28% of revenue from international, and FileNET got 24% of revenue from international. We note that FileNET's results were helped by a $10M transaction that closed in the quarter. Open Text, the strongest standalone performer in the ECM space, got 42% of revenue from international, hence a greater boost from exchange rate effects. II. INDUSTRY NEWS Compuware agreed to acquire Covisint. Formerly a B2B exchange hub for the automotive industry, Covisint sold the auction services portion of its business to FreeMarkets last month. Compuware is buying the portal and messaging platform connecting automotive exchange participants and enabling commerce and collaboration. Compuware expects the transaction to add $20M-$25M revenue and $0.01-$0.02 EPS to FY05 results. Embarcadero's head of sales, Walter Scott, resigned to accept a CEO position at a start-up software company. The company is in the process of searching for a new head of sales. In the interim, Rob Oliphant, head of Embarcadero's international operations, will serve as interim head of global sales. Oliphant worked with Scott to establish the current sales strategy, and is currently based in the UK. The Software Field Guide Page 3 of 6

4 Companies mentioned in The Software Field Guide that are covered by Piper Jaffray & Co.: BMC Software, Inc. (BMC,$ $19.85, MP, #) Borland Software Corporation (BORL,$ $10.40, MP, #+) Computer Associates International, Inc. (CA,$ $26.50, OP, #) Compuware Corporation (CPWR,$ $8.26, MP, #) Embarcadero Technologies, Inc. (EMBT,$ $13.33, OP, #=) FreeMarkets, Inc. (FMKT,$ $8.95, MP, #) Interwoven, Inc. (IWOV,$ $12.84, OP, #) Mercury Interactive Corporation (MERQ,$ $48.50, OP, #) Quest Software, Inc. (QSFT,$ $15.96, MP, #) SeeBeyond Technology Corporation (SBYN,$ $4.84, OP, #) Stellent, Inc. (STEL,$ $8.62, MP, #+=) Vignette Corporation (VIGN,$ $2.38, OP, #) WebMethods, Inc. (WEBM,$ $11.26, OP, #) The Software Field Guide Page 4 of 6

5 Important Research Disclosures Analyst Certification Gene Munster, Tad Piper, and David Rudow The views expressed in this report, including the Key Points and Risk sections in particular, accurately reflect my personal views about the subject Company and the subject security. In addition, no part of my compensation was, is, or will be directly or indirectly related to the specific recommendations or views contained in this report. Research Disclosures The following disclosures apply to securities mentioned in this report if and as indicated: (#) Piper Jaffray was making a market in the Company s securities at the time this research report was published. Piper Jaffray will buy and sell the Company s securities on a principal basis. (^) A Piper Jaffray analyst who follows this Company or a member of the analyst s household has a financial interest (a long equity position) in the Company s securities. (@) Within the past 12 months Piper Jaffray was a managing underwriter of an offering of, or a dealer manager of a tender offer for, the Company s securities or the securities of an affiliate. (>) Piper Jaffray has received compensation for investment banking services from the Company within the past 12 months. (<) Piper Jaffray expects to receive or intends to seek compensation for investment banking services from the Company in the next 3 months. (~) A Piper Jaffray officer, director, or employee (other than a research analyst who follows the Company) is an officer and/or director of the Company. (+) Piper Jaffray and its affiliates, in aggregate, beneficially own 1% or more of a class of common equity securities of the Company. (=) Piper Jaffray has received compensation for non-investment banking securities-related services from the Company within the past 12 months. (&) A Piper Jaffray analyst who follows this Company has received compensation from the Company in the last 12 months. (*) Piper Jaffray and/or its employees (other than the analyst who follows this Company) own securities of this Company that were acquired prior to the Company s IPO. Rating Definitions Investment Opinion: Investment opinions are based on each stock s return potential relative to broader market indices*, not on an absolute return. Outperform: Expected to outperform the relevant broader market index over the next 12 months. Market Perform: Expected to perform in line with the relevant broader market index over the next 12 months. Underperform: Expected to underperform the relevant broader market index over the next 12 months. * Russell 2000 and S&P 500 Risk Rating: Our focus on growth companies implies that the stocks we recommend are typically more volatile than the overall stock market. We are not recommending the suitability of a particular stock for an individual investor. Rather, it identifies the volatility of a particular stock. Low: The stock price has moved up or down by more than 10% in a month in fewer than 8 of the past 24 months. Medium: The stock price has moved up or down by more than 20% in a month in fewer than 8 of the past 24 months. High: The stock price has moved up or down by more than 20% in a month in at least 8 of the past 24 months. All IPO stocks automatically get this volatility rating for the first 12 months of trading. The Software Field Guide Page 5 of 6

6 Disclaimer Piper Jaffray research analysts receive compensation that is based, in part, on the firm's overall revenues, which include investment banking revenues. Piper Jaffray research analysts who follow this Company report to the Head of Investment Research who, in turn, reports directly to the Chief Executive Officer of Piper Jaffray. This material is based on data obtained from sources we deem to be reliable; it is not guaranteed as to accuracy and does not purport to be complete. This information is not intended to be used as the primary basis of investment decisions. Because of individual client requirements, it should not be construed as advice designed to meet the particular investment needs of any investor. It is not a representation by us or an offer or the solicitation of an offer to sell or buy any security. Further, a security described in this release may not be eligible for solicitation in the states in which the client resides. Officers or employees of affiliates of Piper Jaffray & Co., or members of their families, may have a beneficial interest in the Company's securities and may purchase or sell such positions in the open market or otherwise. Notice to customers in the United Kingdom: This report is a communication made in the United Kingdom by Piper Jaffray & Co. to market counterparties or intermediate customers and is exclusively directed at such persons; it is not directed at private customers and any investment or services to which the communication may relate will not be available to private customers. In the United Kingdom, no persons other than a market counterparty or an intermediate customer should read or rely on any of the information in this communication. Securities products and services offered through Piper Jaffray & Co., member SIPC and NYSE, Inc., a subsidiary of Piper Jaffray Companies. Additional information is available upon request. No part of this report may be reproduced, copied, redistributed or posted without the prior consent of Piper Jaffray & Co Piper Jaffray & Co., 800 Nicollet Mall, Suite 800, Minneapolis, Minnesota The Software Field Guide Page 6 of 6