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1 SaaS/Application Software HCM 2020: Collaborative, Connected, and Converging REPORT HIGHLIGHTS: We are expanding our coverage of the Human Capital Management (HCM) software space, initiating coverage on both Healthstream (HSTM) and Workday (WDAY) at Buy, while assuming coverage of Cornerstone OnDemand (CSOD), upgrading that name to Strong Buy from Buy; assuming coverage of Paylocity (PCTY) at Buy; and assuming coverage of Ultimate Software (ULTI), upgrading that name to Buy from Hold. Our research indicates overall customer demand within the HCM space remains healthy and at elevated levels. While the buzz in the HCM space around 2010 was about new greenfield applications to automate Talent Management (TM), we believe today s HCM market represents a more comprehensive approach to workforce management driven by some of the most leading-edge companies currently in the Cloud applications market. The result has been for HCM applications to evolve from back-office systems of record to the forefront of systems of engagement. Our best HCM ideas for the remainder of 2015 are CSOD, PCTY, and ULTI. While we believe overweight exposure to the entire group is warranted given strong secular trends and consistently strong execution, we believe these three names have the best opportunity to outperform over the remaining seven months of the year based on several individual characteristics. We have favorable dispositions to operating models and execution at both Healthstream and Workday, believing both can outperform the broader software space throughout 2015, but individual challenges may limit their respective upside potential. For HSTM, uncertainty around the headwind posed by the looming decline in ICD-10 revenues could limit upside until better visibility into this impact is gained. For WDAY, we believe its industry-high valuation limits upside potential as additional multiple expansion seems unlikely unless sales, which have been strong, can reaccelerate growth. We note that we have also published individual company notes for WDAY, HSTM, PCTY, ULTI, and HSTM simultaneously with this report. May 19, 2015 Topic of Discussion: Human Capital Management (HCM) software space Contributing Analysts Scott Berg (763) Companies Mentioned in Report: Cornerstone OnDemand, Inc. (CSOD: $31.76, PT: $40.00) Paylocity Holding Corp. (PCTY: $33.67, PT: $40.00) Workday, Inc. (WDAY: $91.90, PT: $107.00) HealthStream, Inc. (HSTM: $28.06, PT: $33.00) Ultimate Software Group, Inc. (The) (ULTI: $168.58, PT: $195.00) Sector Chart Nasdaq (NDA) 05/19/15 Price 4, , , , , , , , , Jun-14 Jul-14 Aug-14 Sep-14 Oct-14 Nov-14 Dec-14 Jan-15 Feb-15 Mar-15 Apr-15 May-15 Relevant disclosures begin on page 71 of this report.

2 HCM 2020: Collaborative, Connected, and Converging We are expanding our coverage of the Human Capital Management (HCM) software space, initiating coverage on both Healthstream (HSTM) and Workday (WDAY) at Buy, while assuming coverage of Cornerstone OnDemand (CSOD), upgrading that name to Strong Buy from Buy; assuming coverage of Paylocity (PCTY) at Buy; and assuming coverage of Ultimate Software (ULTI), upgrading that name to Buy from Hold. Our research indicates that overall customer demand within the HCM remains healthy and at elevated levels. While the buzz in the HCM space around 2010 was about new greenfield applications to automate Talent Management (TM), we believe today s HCM market represents a more comprehensive approach to workforce management driven by some of the most leading-edge companies currently in the Cloud applications market. The result has been for HCM applications to evolve from back-office systems of record to the forefront of systems of engagement. Our best HCM ideas for the remainder of 2015 are Cornerstone, Paylocity, and Ultimate Software. While we believe overweight exposure to the entire group is warranted given strong secular trends and consistently strong execution, we believe these three have the best opportunity to outperform over the final seven months of this year based on several individual characteristics: CSOD: For Cornerstone, we believe the recent chatter around competitive issues with Workday and even Oracle (ORCL not rated) are masking improving fundamentals that were issues in 2014 but have reversed in The company s current EV/revenue valuation of 3.7x FY16 revenues remains at a 25-30% discount to other SaaS companies growing CY15 revenues 25-30% Y/Y. PCTY: For Paylocity, adoption of Cloud-based core HRMS and payroll solutions has accelerated over the last two years and we believe these demand levels are sustainable for at least the next three years. As a result, we see significant upside potential to FY16 consensus revenue estimates, and we believe this could drive Y/Y growth from the current high 20% range to near 35%. ULTI: For Ultimate, we believe the recent sell-off after 1Q15 results has created an excellent buying opportunity for one of the most consistent execution stories to date in the SaaS subsector. Like Paylocity, Ultimate continues to benefit from elevated HCM spending levels led by its robust payroll platform, but it may have the best opportunity to benefit from the burgeoning trend of customers seeking to purchase TM applications from the same core HRMS and payroll vendor. We have favorable dispositions to operating models and execution at both Healthstream and Workday, believing both can outperform the broader software space throughout 2015, but company-specific challenges may limit their upside potential. For Healthstream, the uncertainty around the growth headwind posed by the looming decline in ICD-10 revenues could limit upside to the stock until better visibility into this impact is gained. For Workday, we believe its industry-high valuation limits upside potential as we believe additional multiple expansion is unlikely unless sales, which have been strong, can reaccelerate growth. Page 2 of 75

3 Table of Contents HCM 2020: Collaborative, Connected, and Converging... 2 Trends driving the HCM demand into Market Overview... 7 Cornerstone OnDemand (CSOD) Investment Thesis Valuation Investment positives Investment Concerns Company Overview Cornerstone OnDemand Products People Cornerstone OnDemand Management Financials Figure 13 Cornerstone OnDemand Income Statement Figure 14 Cornerstone OnDemand Balance Sheet Figure 15 Cornerstone OnDemand Statement of Cash Flows Healthstream (HSTM) Investment Thesis Investment positives Investment Concerns Valuation Company Overview HealthStream Products HealthStream People: Financials Figure 24 HealthStream Income Statement Figure 25 HealthStream Balance Sheet Figure 26 HealthStream Statement of Cash Flows Paylocity (PCTY) Demand Trends Have Velocity; Raise PT to $ Investment Thesis Investment positives Investment Concerns Valuation Company Overview Paylocity Products Paylocity People Page 3 of 75

4 Financials Figure 32 Paylocity Income Statement Figure 33 Paylocity Balance Sheet Figure 34 Paylocity Statement of Cash Flows Ultimate Software (ULTI) Investment Thesis Valuation Company Overview Ultimate Products Ultimate People Financials Figure 40 Ultimate Software Income Statement Figure 41 Ultimate Software Balance Sheet Figure 42 Ultimate Software Statement of Cash Flows Workday (WDAY) First SaaS Horizontal Platform Executing Well; Initiate with Buy, $107 PT Investment Thesis Valuation Company Overview Workday Products Workday HCM Workday Financial Management Integrated Big Data analytics through Insight Applications Workday Student Workday People Financials Figure 51 Workday Income Statement Figure 52 Workday Balance Sheet Figure 53 Workday Cash Flow Statement Page 4 of 75

5 Trends driving the HCM demand into 2020 We believe there are several factors driving the current demand for HCM software, which we expect to last for several years. The underlying primary driver is the importance of workforce management in corporate executive ranks. Concerns about the ability to attract and retain top talent is often cited as a top two priority for CEOs in several studies every year. The industry has dubbed this challenge the war for talent. We believe this executive priority has driven the mass adoption of Talent Management software over the past 10 years as companies seek better methods to align individual goals with corporate goals, better methods to measure performance in order to effectively compensate performance levels, and also better methods to properly train its workforce to carry out stated corporate goals. We lay out several drivers below that shape our thesis on the HCM software space over the next couple years. In aggregate, we believe these drivers combined can sustain a healthy growth rate in the space through Driver #1: Unified Suites Are Winning, Sort Of We are big believers that over time, application suites tend to win over point solutions as customers seek fewer total vendors and products that are more integrated out of the box, thus requiring less integration. We believe this theme has been playing out in the HCM space over the last five to eight years as Talent Management vendors have expanded their products beyond their core functional areas to encompass a broader set of functionality for Recruiting, Performance Management, and Learning Management. More recently, core HRMS and payroll vendors have raced to surround their core systems with additional Talent Management applications to create a broader, more integrated HCM suite. As a result, our research shows that customer buying preferences have shifted greatly over the last 10 years from purchasing point solutions to purchasing integrated Talent Management suites, and now a slight shift to purchasing HRMS, payroll, and TM all in one suite. We believe the number of customers actually selecting the all-encompassing HR suite is much higher than it was five years ago, but the total number is likely no better than 10% and more prevalent downmarket. However, our recent industry checks suggest interest in the full HCM suite is beginning to accelerate. Driver #2: Adoption, and subsequent use, of HCM software lags current product functionality, throttling demand to create a long tail We believe the biggest impediment to using HCM software today and deriving maximum ROI revolves around customers inability to change or adapt longstanding complex internal corporate HR processes to newer best practices. Our research indicates that the majority of mid-sized to large enterprise customers continue to use HR processes written and adopted almost a decade ago or longer in many cases. Often, the processes were written around an implementation of on-premise core HRMS software (i.e., PeopleSoft or Lawson) and has not been updated meaningfully as these large Systems of Record have been upgraded through the late 1990 s or 2000 s. Exhibit #1 below helps illustrate this dynamic. We believe many companies internal processes remain somewhere between Strategic HR and Integrated Talent Management, yet much of today s modern HR software is developed with the processes and functionality required to deliver Business-Driven HR. Even though reported HCM software growth rates remain robust at roughly 10%, we believe the slow evolution of these internal HR processes has actually limited HCM software demand over the last several years. We believe the good news is that more companies are beginning to use the purchase of new HCM software, especially for core HRMS and payroll, as the catalyst to modernize these aging internal processes which we believe can sustain the current demand trends for the foreseeable future. Page 5 of 75

6 Figure 1 The Evolution of HR Current Internal Processes Current HCM Technology Source: Bersin and Associates Driver #3: Mobile use highest in HCM than any other Enterprise Software segment, but adoption remains in the early stages While mobile functionality has been a buzzword in Enterprise Software and has seen more than its share of development resources thrown its way, our research indicates the use of mobile functionality broadly remains underwhelming except for applications used by sales people when in the field. However, we believe mobile use in the HCM space is beginning to increase rapidly and will likely be the most used mobile corporate application broadly within the workforce, which should spur additional spending. We believe drivers of this demand include time clock punching on an app that will replace the punching of an actual time clock for hourly workers, the completion of performance reviews, and the learning or training employees while in the field. While most of the large HCM vendors already develop deep mobile functionality today, most customers have yet to embed mobile in their current HR processes. Driver #4: Big Data HR: More Pipe Dream Than Substance... But The Dream is Becoming Reality We believe the dream of applicable Big Data usage within the HR space has been a convoluted mix of hope and frustration in what has historically been called Workforce Analytics. The hope revolved around a new set of applications from companies like Aruspex (private) or Inforhm (SAP) that could deliver deep insight into current workforce trends and planning. The frustration came from software that was often too complex, thus requiring more professional services to use than software likely should, or applications not truly tailored for HR like Cognos or Business Objects. The result was low adoption rates and annual market spend that was less than $200MM, according to Forrester. However, we believe this HR Big Data vision is starting to become reality with deeper analytics applications from companies like Evolv (acquired by CSOD), Visier (private), and Workday as these applications are more software-centric and easier to derive actionable business insights from than ever. Page 6 of 75

7 Driver #5: The Book on HCM Software Has Yet to be Completed... Innovation Levels Healthy While dominant vendors in the HCM Software space have established themselves over the last couple years and the large ERP vendors have made their product investments through various acquisitions, much of the institutional investment community is left wondering whether the vendor landscape has all been written. However, we believe prevalence of Software-as-a-Service platforms across all HCM functional areas today has increased the opportunity for new vendors to innovate both on the fringe edges of the space but also within core product areas, with new concepts like machine learning and gamification, or even new methods to manage employee self-service. Companies like the Marcus Buckingham Company are pushing new processes to manage a workforce that, if adopted, would require companies to alter their view on how they leverage HCM software to attain workforce goals. We believe companies like cfactor (private), Dovetail (private), HireVue (private), icims (private), and Jibe (private) are innovating in functional areas where the more well-known HCM vendors are not, but that the more well-known HCM vendors may seek out in the next several years. Driver #6: HCM No Longer Greenfield, Secular Move to Cloud-based HRMS/Payroll Yields Elevated Demand Levels The HCM no longer offers a pure greenfield growth opportunity like Talent Management did over the last 10 years,and penetration rates of core HRMS and payroll are essentially 100%. However, overall market growth remains robust driven by the early stages of a secular move from on-premise HRMS and payroll systems to Cloud-based vendors as well as the replacement of many generation one and generation two Talent Management solutions. The overall HCM software market is expected to grow at nearly 10% according to Gartner, IDC, and Forrester, which we classify as a robust growth market even without a true greenfield growth area. Market Overview The HCM software marketplace has gone through a significant amount of change. The 1990s saw the mass adoption of large Human Resource Management Systems (HRMS) that collected mostly static yet very structured employee data including hire date, salary, benefits information, etc. PeopleSoft was the most widely recognized HRMS company to capitalize on this adoption trend in the 1990s yet other large Enterprise Resource Planning (ERP) companies such as Oracle/PeopleSoft (ORCL-not rated), and SAP (SAP-not rated) built various HRMS components into their respective ERP software. Today s HCM software marketplace is defined by companies seeking to shape, or reshape, the management of a company s workforce. The 1980s and 1990s saw companies adopt software-based solutions like ERP and financial software to manage a company s physical assets and production abilities. The late 1990s and early 2000s saw a strategic shift to focus on a company s human capital once the hard assets had the ability to be properly managed. This strategic shift in HR software moved companies away from simply storing this static employee data to actively managing various stages of an employee s life with a company. While HRMS systems are still required to contain this important, static information, today s HR software companies are improving the quality of the hiring process resulting in more or better qualified candidates hired and aligning their future work with corporate objections to ultimately maximize shareholder value. This concept is widely known as Human Capital Management. Exhibit #2 below illustrates this evolution of HR, and subsequently HR software, which has shifted over the past 20 years from a compliance-driven set of applications that automate manual processes to applications that can drive business performance. Page 7 of 75

8 Figure 2 Evolution of HR Software Source: Bersin by Deloitte Until the recent boom of Cloud-based platforms, HRMS functionality was developed using client-server architecture in the 1980s, comprising benefits administration, payroll, time and attendance, scheduling, and absence management. Talent Management applications started in the 1990s as individual point software solutions which were designed to meet a single specific need in the human resource process. Recruiting software and Learning Management software were the first point solutions to appear on the scene mainly because they were able to drive efficiencies through automating manual processes such as collecting and distributing resumes, tracking open job requisitions, and distributing content for employees to learn from. Adoption and usage of these Talent management systems has significantly increased over the past decade with the advent of the Software as a Service platform utilizing Web 2.0 technologies making the software easier and more intuitive to use, while also making them stickier in the long run. Page 8 of 75

9 Figure 3 Primary Human Capital Management Suite Components Workforce Planning (Analytics) Recruitment Performance Learning Management (LMS) Applicant Tracking Onboarding Social Sourcing Candidate CRM Goals Management Performance Management Succession Management Compensation Management Structured Training Social Learning Extended Learning HRMS Transaction Systems and Payroll Source: Needham & Company, LLC Although this vision of the HR software industry does not completely exist today, many vendors in the space are developing or have developed unified platforms that encompass multiple components of these five segments of HCM software. We believe that the desire for a unified platform will partially drive buying decisions over the next three to five years, and that the vendors that execute this talent vision successfully will in the long run have the best opportunity for both revenue growth and sustained success as companies seek to replace individual point systems with unified, integrated HR software platforms. Several surveys that we have conducted of HR managers appear to validate our opinion, one showing that 78% of respondents desire to use a single, unified platform HCM platform versus a best-of-breed approach. Competitors The overall HR software market has a large number of vendors but few vendors that we believe are truly competitive across multiple functional areas in the space. We break the market into three primary subsectors: platform vendors, point solution vendors, and service bureaus. Oracle and SAP are the largest vendors in the HR software market, each with approximately 15-20% of the total market. Exhibit #4 below details 2013 market shares by vendor according to Deloitte. Page 9 of 75

10 Figure 4 HCM Vendor Market Share by Revenues Source: Deloitte As noted above, vendors in the HCM space differ greatly in their respective product offerings. In Exhibit #5 below, we summarize this functionality by vendor. Figure 5 Functionality Comparison by HR Software Vendor HRMS HRMS (License) (Multitenant SaaS) Source: Company data, Needham & Company, LLC HRMS (Hosted License) Time & Payroll Recruiting Performance Compensation Succession Learning Social Attendance Software Management Management Management Management Collaboraton Cornerstone OnDemand X X X X X X Halogen X X X X X HealthStream X X X icims X Infor X X X x X X X X X X Kenexa (acquired by IBM) X X X X X Kronos X X X X Oracle X X X X X X X X X X X Paycom X X X X X Paylocity X X X X Peoplefluent X X X X X Saba X X X X X X SAP X X X X X X X X X X X SilkRoad X X X X X X X SumTotal X X X X X X X X Ultimate Software X X X X X X X Workday X X X X X X X HRMS Software The Human Resource Management Software market, which often includes payroll processing, is considered to be the largest subsector of the HCM market, with annual revenues in excess of $10B or even $15B according to several sources. Penetration rates Page 10 of 75

11 within this subsector are essentially 100% because every company requires a payroll service or vendor to compute payroll for its employees. Given this saturation level, Forrester and Gartner both expect this market to continue growing in the low to midsingle digit level over the next several years. PeopleSoft (Oracle) dominated the early core HRMS software space with strong competition from both Lawson (now Infor private) and SAP while ADP, Ceridian, and Paychex (PAYX-not rated) are the most well known service bureaus in the payroll space. However, the SaaS Cloud delivery model has spurred several new vendors to experience rapid growth as customers seek alternatives to legacy client/server vendors and service bureaus. Ultimate Software and Workday are perhaps the most well-known new SaaS vendors in this space, with both achieving significant growth over the last decade, but both focus the mid-market and enterprise customer segments. Paylocity and Paycom (PAYC-not rated) are the most well known vendors targeting the SMB to mid-markets segments. We believe both ADP and Ceridian have made significant product investments to deliver more modern core HRMS systems with Ceridian through its acquisition of Dayforce, emerging with the early lead among the large service bureaus. Recruiting Software Recruiting software is probably the most well-known software solution within the Talent Management software suite purely because of how visible it is in the employment process for most mid-sized to enterprise level companies. Recruiting software may be the most mature segment in the space and no longer offers the dramatic near-term and long-term growth opportunities as it did a decade ago as virtually all larger companies globally now have some sort of recruiting software. We believe overall domestic growth in this segment will be limited to expanding the adoption within mid- to smaller sized companies, which are most likely using a home-grown or manual process. Any growth of an individual recruiting vendor in the larger enterprise space would most likely be a result of replacing another vendor. A number of reports peg the current recruiting software market to be roughly $1.5 billion annually, with annual growth of roughly 10%. The recruiting software space is dominated by three larger vendors: Taleo (Oracle) and Kenexa (IBM) in the U.S. and Lumesse (private) in Europe. We believe Taleo and Kenexa platforms still account for roughly 40%+ of the current market, and they have historically had the lion s share of domestic deals within the large enterprise market. However, since their respective acquisitions, the Recruiting market has seen several other vendors emerge and take market share. These vendors include icims (private), PeopleFluent (private), and SilkRoad (private), while public vendor Cornerstone OnDemand released a new recruiting product roughly two years ago that is gaining traction. This market also contains several other vendors including Bullhorn (private), Findly (private), Jobvite (private), Saba (private), SuccessFactors (SAP), Ultimate Software, and Workday. Performance Management Software We believe Performance Management software experienced the most growth of any segment within HCM software over the last five years. Performance Management software allows companies to take a more proactive approach to managing, developing, and evaluating an employee s work goals and performance along with their individual professional goals by better aligning these goals with the company s short-term and long-term objectives. As a result, employee productivity tends to increase as employee execution better matches company strategy. A complete Performance Management suite will typically contain the following components: Page 11 of 75

12 Goals Management Goals management allows managers to automate the periodic review process and assess performance by aligning individual work production goals with company objectives. Profile of Employee Strengths and Weaknesses Understanding an employee area of strengths and weaknesses can lead to assigning the proper human capital to particular goals. Succession Management When combined with the data provided by goals management and data on employee skillsets, companies can properly plan for organizational growth and attrition by identifying the competencies of internal candidates to meet future needs. Compensation Management Compensation Management allows companies to link employee compensation to specific employee goals and objectives, creating a pay for performance culture and thus helping to drive productivity increases. While compensation management is considered by some to be a separate component within the Talent Management suite of applications, we believe it is actually an integral part of the Performance Management suite. SuccessFactors (SAP) has dominated the early Performance Management space with significant installations within the large enterprise. Vendors such as Authoria (now PeopleClick), Cornerstone OnDemand, Halogen (TSE:HGN not rated), Kenexa (IBM), Oracle, Saba and SilkRoad are all established vendors within the Performance Management space and have had varying degrees of success in the SMB to enterprise levels. We believe Cornerstone and Oracle, partially through its acquisition of Taleo, have gained the most market share behind SuccessFactors. Learning Management Systems We have found the Learning Management System segment within the Talent Management suite to be experiencing the most product and market transformation within the TM space recently. This corporate learning space is most well-known to investors as a very structured learning process more known for compliance training and formalized training of internal employees. This area within corporate learning has experienced the slowest growth over the last three to five years. We believe this to be true for several reasons. First, similar to the Recruiting software market, most larger enterprises that could appropriately use a LMS have already purchased one if not multiple LMS products. However, unlike the SMB Recruiting software market, which we believe still offers growth opportunities, the need for a LMS within this SMB market is not as significant. What we find instead is that the SMB market will purchase the required learning sessions from third-party vendors on an as-needed basis versus bringing in an entire LMS. Secondly, the LMS space is a complex space in general because vendors, or their clients, also require access to appropriate content to effectively train their target audience. Third, formal corporate training budgets are cyclical and lack annual continuity as they tend to be one of the first expense line items cut during tougher economic conditions and are frequently the last to come back. However, in recent years, corporate learning products have evolved to address the complex environments of social learning and extend learning to customers external value chains. Social learning software helps to foster knowledge sharing among employees on a more informal level through the user adding social commentary within the more formal LMS product. This process creates a more structured method and system of record to capture informal learning that we believe represents 70-80% of all learning that happens while at work. The extended learning process creates a structured environment for companies to create learning content that can be pushed or pulled by a company s value chain that could contain channel partners, franchises, Value Added Resellers, and ultimately the end buyers and users of the customer s products. The benefits of this extended learning platform are numerous, including allowing this value chain to consume product information on demand, more efficiently train this value Page 12 of 75

13 chain on new products while lowering in-person training travel costs, and creating online value chain support eco-systems that allow individuals to exchange knowledge in a social learning environment. The LMS market is considered to be roughly a $ B annual market by most industry analysts. We believe that the market growth we detail below, however, does not properly account for the changing dynamic of social learning and extended corporate learning. Cornerstone OnDemand, Plateau (SuccessFactors), Saba and SumTotal Systems are the most well-known LMS vendors. However, the LMS space numbers over 30 vendors including horizontal vendors like NetDimensions (private), Oracle, and SilkRoad while also comprising many industry-specific vendors like Healthstream (HSTM, rated Buy) in Healthcare. Workforce Planning We believe Workforce Planning to be both the starting and the ending point within the Talent Management cycle. Companies need to have near-term and long-term strategic plans for their respective workforces to meet the corporate challenges and initiatives that lie ahead of them. While Recruiting software can assist in bringing new employees into an organization, Performance Management software can manage them during their time with a company, and a LMS can help fill in skill gaps, proper workforce planning is ultimately required to successfully pull it all together. However, Workforce Planning remains a more manual and consultative business rather than one driven by software applications, as with the other areas of HCM software. We believe this to be true mainly because a pure software solution that is intelligent enough to ask appropriate workforce questions does not yet exist. Most of the software in the space revolves around analytic-type tools to gather appropriate corporate data. While larger companies may be able to absorb such a high-dollar consultative cost, we believe this approach makes proper workforce planning at the SMB level somewhat prohibitive, which in turn limits the market opportunity. In 2010, SuccessFactors was the first HCM vendor to make the jump into the Workforce Planning space, acquiring Australian-based Inform for $40.5MM in a combined cash and stock transaction. Cornerstone OnDemand also recently entered the Workforce Analytics/Big Data space through its recent acquisition of Evolv for $44MM. We believe the most exciting new entrant into the Workforce Planning space over the last several years to be Visier (private), which was started by a number of former Business Objects (SAP) executives. HCM Software Market Opportunity We believe the overall HCM software market opportunity to be quite large in general, but ultimately we find it difficult to gauge the size precisely for two main reasons: ) first, much of the spend for Talent Management systems that are part of ERP and HRMS systems cannot be quantified properly as this spend is not always specifically broken out by ERP vendors; and 2) second, and probably more importantly in our view, hypothetically every company large and small should systematically manage their employees corporate life cycles. So while we believe the long-term market opportunity is quite large, we focus on near-team spend opportunities and growth drivers. Gartner believes 2013 spend on HCM applications to be roughly $8.3B, and believes it should average growth of approximately 7% through IDC estimates core HRMS represents roughly half of all HCM spend as of 2011, and expects this segment to grow at an annual rate of 8.2% through Forrester projects the more mature markets of LMS and Recruiting software will grow at a CAGR of roughly 8% and projects Performance Management to grow at the fastest pace in the space, roughly 16.5% Page 13 of 75

14 growth through Exhibit #6 below details Forrester s estimates. However, Bersin and Associates believe the Talent Management market to be larger than Forrester s estimates, most notably with LMS, which it estimates to be growing at a rate of 14.6% in 2012 and 10.4% in 2013 for a total LMS market of roughly $1.9B. Bersin s LMS estimate is three times the size of Forrester s LMS estimates. Figure 6 Global HR Software Market Growth by Product Category 6,000 5,000 HRMS 4,000 3,000 Performance management Learning management 2,000 Recruiting 1, E Compensation and benefits E CAGR HRMS 3,980 4,348 4,740 5,119 5,477 5, % Performance , % management Learning % management Recruiting ,056 1,151 1,231 1, % Compensation ,033 1, % and benefits Total 6,663 7,290 7,963 8,662 9,337 10, % Source: Forrester Page 14 of 75

15 Cornerstone OnDemand (CSOD) Assuming Coverage: Execution Improving, Favorable Environment; Upgrading to Strong Buy, PT to $40 Investment Thesis We are assuming coverage of Cornerstone OnDemand (CSOD) with a Strong Buy rating (upgrading from Buy, see last note published 2/12/15) and a $40 price target. Cornerstone is a market leader in the Human Capital Management (HCM) software space that we believe is well positioned in a space seeking new leadership. We believe the company can benefit from 1) elevated spending levels for its core Talent Management applications, 2) strong product vision, 3) weakening competition, and 4) shifting customer purchasing preferences, factors that we believe together create an attractive investment opportunity for growth investors. Our checks indicate fundamentals are improving and the short thesis remains a hypothetical several years off, if ever in our view. Valuation We derive our $40 price target for Cornerstone OnDemand using an EV/revenue valuation methodology as we believe this methodology allows for consistent comparison across Software-as-a-Service (SaaS) companies. SaaS companies like Cornerstone OnDemand have historically traded at 2-8x forward-year revenue multiples, and we believe Cornerstone with what we expect will be a hyper growth period over the next three years should be valued with a growth premium on FY13 valuations that are discounted back to the beginning of CY12 to derive our 12 month price target. We value the company at 5.0x our FY16 revenue estimate of $432MM. We arrive at an enterprise value of roughly $2.16B, and after adding in approximately $20MM in net cash, we believe CSOD should have a market value of $2.18B, or $40 per share. Investment positives Spending on Talent Management applications to remain robust in 2015 and The Talent Management market is a $6B plus market and is expected to remain a double-digit growth market in 2015 and 2016 according to several industry analysts, including Forrester and Gartner. Our research indicates this demand should be broad based across the Talent Management sector, led by spending on replacements of early-generation TM solutions, spending on broader suites, and new spending on social learning and analytics. We believe Cornerstone s current product portfolio is well positioned to benefit from all these demand drivers with one of the broadest TM suites in the market. Billings upside likely in 2015 versus current consensus. Our industry checks indicate that demand for the company s product is higher than current Street sentiment suggests and that CSOD can deliver upside to current billings estimates in Q billings growth of 27.8% beat consensus estimates of 24%, the second consecutive quarter of deal outperformance. While exchange rates have created a headwind for 2015 growth that we believe is already priced in; however we identify three factors that we believe currently are not well understood by the market: 1) we believe the competitive environment has recently become incrementally more favorable to Cornerstone, 2) we note that pricing has stabilized, and 3) we note strong sales of CSOD s new applications. We believe that the combination of these factors could deliver upside to 2015 sentiment. Talent Management has shifted toward a suite. Our independent research and other industry surveys have started to detail customer preferences for TM suite Page 15 of 75

16 platforms that include Recruiting, Performance Management, and Learning Management versus trying to integrate point solutions. We believe Cornerstone s current platform is among the best positioned to benefit from this increasing demand trend, with strength in Learning Management, Performance Management, and a relatively new Recruiting module that we believe is selling better over the last year. Although completely new, we believe the company s new Big Data applications will also contribute in 2H15 and 1H16. Large upsell opportunity could more than double existing revenues. Although the majority of Cornerstone customers have its flagship LMS application, penetration rates of its remaining applications remains low. As detailed in exhibit #7 below, roughly 60% of customers have Performance Management, but less than 1/3 have any of its remaining applications of Succession Management, Connect, Compensation Management, recruiting or Onboarding. We believe upsells that leverage the HCM suite as detailed above can increase non-lms revenues 10% annually, which would result in a doubling of revenues from existing customers or more over the next decade. Figure 7 Cornerstone Product Penetration Rates Learning Performance Succession Connect Compensation Recruiting Onboarding Existing Client Penetration Client opportunity Source: Company Reports and Needham & Company Estimates We prefer subscription-based revenue models given better visibility. We prefer the SaaS delivery model in general to on-premise perpetual-license software delivery models because the SaaS model delivers more predictable near-term revenue and cash flows while also being more profitable over the long term. We believe this model, when combined with the company s high renewal rates, gives investors a higher level of visibility into the company s near-term financials versus a perpetual license model. Investment Concerns Customer buying preferences shifting toward Talent Management from core HRMS/payroll vendor could limit Cornerstone s sales opportunity. Our research, along with that of several industry analysts, has suggested that some customer buying trends are shifting toward an entire HCM suite comprised of core HRMS, payroll, and Talent Management functionality from the same vendor in an effort to reduce integration points and vendor relationships. While we believe this preference is a small section of the market and likely remains limited in the short term, any acceleration in this purchasing behavior could negatively impact Cornerstone since it lacks a core HRMS and payroll solution today. Talent Management market highly competitive. The Talent Management (TM) industry is extremely fragmented and highly competitive at all customer segment levels. While we believe Cornerstone s integrated suite of TM applications offers a Page 16 of 75

17 unique and highly in-demand value proposition, the company does compete against many larger and better capitalized competitors that could exert pricing pressure. We expect this market to remain highly competitive over the near term, requiring Cornerstone to maintain innovative product development and competitive pricing. Learning software demand is sensitive to economic cycles. Our research has shown employee training budgets are one of the early budget categories to be reduced or eliminated by many companies in economic downturns. We believe LMS purchasing decisions have similar sensitivity, as is evident with most LMS vendors that struggled to grow revenues in CY2009 then experienced meaningful revenue growth in Although Cornerstone has diversified its products significantly outside of Learning since 2009, much of its new business continues to come from its LMS solution, which we believe would be impacted by a similar economic slowdown. Company Overview Cornerstone OnDemand is a leading provider of HR software solutions within the Human Capital Management (HCM) or Talent Management (TM) space. Adam Miller, Perry Wallack, and Steven Seymour founded the company in 1999 originally as CyberU, but the company was already well known as Cornerstone within the industry and officially changed its name to Cornerstone OnDemand in Today, Cornerstone has built one of the TM industry s most innovative and organically developed software suites that manages all post-hire employee performance while also developing an extended suite of learning software tools that better connect a customer to its external value chain. Cornerstone OnDemand is headquartered in Santa Monica, CA, and had 1,362 employees as of December 31, Cornerstone OnDemand raised roughly $115M through two rounds of venture funding and its initial public offering. The company raised $16M in a round of Series D venture funding in 2007 and $8.7M through a Series E round of venture funding in The company s IPO in March 2011 raised roughly $90M from 7.5M shares priced at $13 each, above its initial range of $9-11 per share. The company plans to use the funds raised during its IPO to repay debt of $5M and for general operations, including expanding its sales force. Cornerstone also raised $253MM in a convertible debt offering in June Cornerstone has completed two acquisitions to date, deploying a total $58.5MM in capital. The company announced the acquisition of Sonar Limited (sonar6) for $14MM. Sonar6 brought Cornerstone a Talent Management platform that now makes up its Cornerstone Growth Edition SMB product. In October 2014, the company acquired Evolv for $44.5MM. The Evolv acquisition brought CSOD deep data science expertise and machine learning applications to leverage with its Big Data initiatives. Since its IPO in 2011, Cornerstone has been one of the fastest growing public software companies based on revenue growth, customer count, and user count. Exhibits 8 and 9 below detail customer and user growth since Page 17 of 75

18 Figure 8 CSOD Customer Count since 2007 Figure 9 CSOD Seat Count since ,500 2,000 1,500 1, ,153 1,631 1, Millions Source: Company reports Source: Company reports Cornerstone OnDemand Products Cornerstone OnDemand develops and markets an on-demand, organically built Talent Management software suite comprising seven applications. While these applications scale well to customers of all sizes and are highly configurable, the company has created different products to address the differing and unique customer needs with the enterprise and mid-market customer segments. Its Cornerstone Enterprise Edition gives customers with over 3,000 employees a more configurable and flexible solution to meet the added complexities for customers with larger needs. The company s Cornerstone Business Edition is targeted for customers with 250-3,000 employees and comes preconfigured to address needs within less complex environments. Cornerstone also sells a product to the SMB segment called its Growth Edition for customers with fewer than 400 employees. This product came from its acquisition of Sonar limited. All of the company software solutions are developed using Microsoft s.net technology platform utilizing Web 2.0 technologies to create a rich and dynamic application set. The company s Learning Management system and Performance Management are the suite s most widely used applications as highlighted in Exhibit #10 below, comprising most of the company s current revenues and new sales. These widely used applications help companies develop their talent and engage employees in an effort to drive better individual and company-wide goal execution. The company s suite also contains five additional enterprise applications with significant ability to scale globally. Succession management software (which we actually consider a critical component to the Performance Management application set) is utilized to build better talent pipelines, and Compensation Management is used to tie compensation in with actual employee performance. The company s social networking/collaboration application called Connect enables customers to create a social learning environment to foster knowledge sharing through informal processes. Recruiting and Onboarding represent the company s two newest applications. Page 18 of 75

19 Figure 10 Cornerstone Products Source: Company reports Product sales model: Cornerstone s primary go-to-market strategy is to sell its products using a direct sales force. The company also has significant partnerships with several partners including ADP, Appirio, AON Hewitt, and Deloitte, among others. Technology: Cornerstone utilizes a modern architecture including a Web Services framework with the Microsoft.NET technology stack. Mobile strategy: We believe the company has undertaken an aggressive mobile strategy with strength in mobile Learning as well as a mobile Recruiting functionality. Competition Cornerstone OnDemand competes against several vendors within each of its product areas. The company competes mainly against Oracle, Saba Systems, SAP, and SumTotal Systems. CSOD can also compete against Halogen, icims, and Peoplefluent at varying times. We believe Cornerstone OnDemand is most competitive against these vendors in the mid-market to enterprise space with customers that have 1,000 or more employees. People Cornerstone OnDemand Management Adam Miller - President and Chief Executive Officer Mr. Miller co-founded the company in 1999 and currently leads the company s strategy, sales, operations and product development efforts. Prior to co-founding Cornerstone OnDemand, Mr. Miller served as an attorney and investment banker with Schroders (now part of Citigroup) and an affiliate of Montgomery Securities. Mr. Miller has a Juris Doctor from the UCLA School of Law, a Master of Business Page 19 of 75

20 Administration from the Anderson School of Business, a Bachelor of Science from the Wharton School and a Bachelor of Arts from the University of Pennsylvania. Perry Wallack - Chief Financial Officer Mr. Wallack co-founded the company in 1999 and has served as CFO since the company s inception. Prior to co-founding the company, Mr. Wallack was a Business Manager with a leading business management boutique firm in Beverly Hills, CA, and spent the early part of his career with Ernst & Young LLP managing a tax and audit staff. Mr. Wallack holds a Bachelor of Arts in Economics from the University of Michigan and is a CPA (inactive). Mark Goldin - Chief Technology Officer Mr. Goldin joined the company as CTO in June 2010 and brings over 15 years experience as a CTO to the company. Prior to joining Cornerstone OnDemand, Mr. Goldin held CTO positions with Green Dot Corporation, Thomson Elite, and DestinationRx. Dave Carter - Vice President of Sales Mr. Carter joined the company in 2004, overseeing all selling efforts as Vice President of Sales since. Prior to joining Cornerstone OnDemand, Mr. Carter had spent nearly 20 years managing HR software and services sales teams with Ceridian, ProBusiness, and most recently with Accenture. Mr. Clark has a Bachelor of Arts from Clark University. Financials We have modeled our Cornerstone OnDemand financial estimates based on several assumptions and data points. These assumptions and data points include: Cornerstone recognizes subscription revenues ratably over the term of its contracts. Recurring revenues comprise roughly 80% of the company s total revenues, which yields visibility into gross margins greater than 70%. The recent material move in the US dollar exchange rate over the last six months has created an approximate 3% headwind to FY15 Y/Y revenue growth given that roughly 30% of revenues are denominated in Euros. Operating margin leverage should increase significantly in this SaaS model as the company s growth profile subsides as growth in sales & marketing spend slows. We expect the company to continue investing heavily for growth in the near term, which will limit overall profitability. We do not expect the company to pay significant cash taxes for several years. FY15 Income Statement Overview We expect Cornerstone to generate FY15 revenue of $339.5MM, representing Y/Y growth of 48.6%. We estimate overall gross margins will remain flat Y/Y Y/Y to 72.6% from 72.6%, reflecting the company s growth investments. We estimate pro forma operating margins will improve slightly Y/Y from (3.9%) to (2.6%), driving non-gaap net income of ($16.4MM) vs. ($17.0MM) in FY14. Our FY15 non-gaap EPS of ($0.30) reflects minimal net income improvement. Page 20 of 75

21 Millions Needham & Company, LLC May 19, 2015 Figure 11 Cornerstone Revenue vs. Operating Margins $500 $450 $400 $432 $350 $300 $340 $250 $264 $200 $150 $185 $100 $119 $50 $11 $20 $29 $47 $76 $ E 2016E Source: Company reports and Needham & Company, LLC estimates 0.0% -10.0% -20.0% -30.0% -40.0% -50.0% -60.0% -70.0% Revenue Operating Margins Cash Flow Cornerstone should be able to generate significant cash flow leverage from its SaaS model given the low incremental costs of adding new customers to its infrastructure. We have estimated FY15 operating cash flow margins to increase Y/Y from 12.5% in FY14 to 13.1% in FY15, which would drive operating cash flows to increase from $33.0MM in FY14 to $44.6MM in FY15. We estimate unlevered free cash flow, operating cash flows less capital expenditures and capitalized software costs will increase from $2.9MM in FY14 to $5.6MM in FY15 as CapEx expenditures increase from $11MM to $14MM and capitalized software increased from $9.5MM to $12.5MM. Figure 12 Cornerstone Cash Flow Estimates E 2016E Operating cash flows ($5,986) ($1,633) $1,705 $1,832 $10,295 $17,431 $33,009 $44,580 $64,600 OCF margins -30.5% -5.6% 3.7% 2.4% 8.6% 9.4% 12.5% 13.1% 15.0% Unlevered Free Cash Flow ($8,297) ($4,699) ($3,885) ($4,932) ($1,888) ($5,143) $2,926 $5,574 $15,100 ufcf margins -42.3% -16.0% -8.3% -6.5% -1.6% -2.8% 1.1% 1.6% 3.5% Source: Company reports and Needham & Company, LLC estimates Balance Sheet Cornerstone has a clean balance sheet with roughly $20.7MM in net cash, net of $253MM in outstanding convertible debt. However, we note several items: Convertible bonds: The company issues $253MM in convertible bonds in June 2013 due July 1, They bear an interest rate of 1.5% per year and have certain call features. The bonds convert for shares of common stock per $1,000 bond, representing a $54.04 conversion price. Goodwill: The company has $25.9MM of Goodwill for the quarter ending March 31, 2015 resulting from its acquisitions of Sonar Limited and Evolv. We do not expect any impairment charges in the near future. DSOs: 1Q15 DSOs were 89 days, down from 95 days in 1Q14 and 102 days in 1Q13. We expect DSOs to fluctuate between 85 to 105 days over the foreseeable future. Deferred Revenues: The company s total deferred revenue balance increased 38% Y/Y in 1Q15 to $180.9MM with short-term deferred revenues increased 30% Y/Y to $168.4MM. Page 21 of 75

22 Figure 13 Cornerstone OnDemand Income Statement Income Statement Q 2Q 3Q 4Q Q 2QE 3QE 4QE 2015E 1QE 2QE 3QE 4QE 2016E Total Revenues 10,976 19,626 29,322 46,608 75, , ,298 57,409 61,468 68,318 76, ,023 74,435 80,093 87,447 97, ,546 98, , , , ,046 Y/Y growth 50.8% 78.8% 49.4% 59.0% 62.0% 58.0% 55.3% 51.9% 38.5% 41.5% 40.1% 42.5% 29.7% 30.3% 28.0% 27.0% 28.6% 32.0% 28.0% 25.0% 25.0% 27.2% Q/Q growth 4.7% 7.1% 11.1% 12.5% -3.1% 7.6% 9.2% 11.6% 0.7% 4.3% 6.6% 11.6% Cost of Revenues 3,887 6,086 8,649 14,211 20,734 32,022 49,972 16,290 16,510 18,409 21,023 72,232 21,351 21,465 23,436 26,637 92,889 26,922 27,475 29,295 32, ,134 Gross Profit 7,089 13,540 20,673 32,397 54,788 87, ,326 41,119 44,958 49,909 55, ,791 53,084 58,628 64,011 70, ,658 71,333 75,044 80,014 89, ,912 Gross Margins 64.6% 69.0% 70.5% 69.5% 72.5% 73.2% 73.0% 71.6% 73.1% 73.1% 72.6% 72.6% 71.3% 73.2% 73.2% 72.7% 72.6% 72.6% 73.2% 73.2% 73.4% 73.1% Operating Expenses Sales and marketing 9,252 16,771 18,638 27,789 44,563 69,462 99,112 31,425 35,187 35,959 41, ,722 41,238 45,252 45,472 51, ,188 53,549 57,411 57,934 63, ,314 % of Revenue 84.3% 85.5% 63.6% 59.6% 59.0% 58.2% 53.5% 54.7% 57.2% 52.6% 53.6% 54.4% 55.4% 56.5% 52.0% 52.5% 54.0% 54.5% 56.0% 53.0% 52.0% 53.8% Research and development 1,738 2,700 2,769 5,470 9,498 13,904 19,131 6,080 6,083 6,616 8,227 27,006 8,595 8,810 8,920 9,074 35,399 11,299 11,021 11,259 11,465 45,043 % of Revenue 15.8% 13.8% 9.4% 11.7% 12.6% 11.6% 10.3% 10.6% 9.9% 9.7% 10.7% 10.2% 11.5% 11.0% 10.2% 9.3% 10.4% 11.5% 10.8% 10.3% 9.4% 10.4% General and administrative 2,564 2,519 4,268 8,194 13,454 19,416 26,667 7,633 8,088 7,218 8,401 31,340 9,050 9,050 9,182 9,562 36,844 9,825 11,482 11,696 12,196 45,200 % of Revenue 23.4% 12.8% 14.6% 17.6% 17.8% 16.3% 14.4% 13.3% 13.2% 10.6% 10.9% 11.9% 12.2% 11.3% 10.5% 9.8% 10.9% 10.0% 11.2% 10.7% 10.0% 10.5% Total Operating Expenses 13,554 21,990 25,675 41,453 67, , ,910 45,138 49,358 49,793 57, ,068 58,883 63,113 63,574 69, ,431 74,673 79,913 80,889 87, ,558 Proforma Operating Income (6,465) (8,450) (5,002) (9,056) (12,727) (15,450) (9,584) (4,019) (4,400) 116 (1,974) (10,277) (5,799) (4,485) 437 1,073 (8,774) (3,341) (4,870) (874) 2,439 (6,645) Proforma Operating Margins -58.9% -43.1% -17.1% -19.4% -16.9% -12.9% -5.2% -7.0% -7.2% 0.2% -2.6% -3.9% -7.8% -5.6% 0.5% 1.1% -2.6% -3.4% -4.8% -0.8% 2.0% -1.5% GAAP & Non Cash Expenses 220 1,032 2,478 38,621 56,273 15,648 28,680 10,734 10,772 12,104 14,303 46,616 14,007 14,350 14,475 14,650 57,482 14,850 15,375 15,900 16,425 62,550 GAAP Operating Income (6,685) (9,482) (7,480) (47,677) (69,000) (31,098) (38,264) (14,753) (15,172) (11,988) (16,277) (56,893) (19,806) (18,835) (14,038) (13,577) (66,256) (18,191) (20,245) (16,774) (13,986) (69,195) GAAP Operating Margin -60.9% -48.3% -25.5% % -91.4% -26.1% -20.6% -25.7% -24.7% -17.5% -21.2% -21.5% -26.6% -23.5% -16.1% -13.9% -19.5% -18.5% -19.7% -15.3% -11.5% -16.0% Total Other Income (expense) (144) (639) (813) (1,321) (206) (334) (2,290) (884) (1,260) (2,145) (1,565) (5,854) (3,178) (1,175) (1,175) (1,175) (6,703) (1,175) (1,175) (1,175) (1,175) (4,700) Adjusted EBITDA n/a (8,285) (5,863) (43,716) (60,492) (11,760) (6,581) (3,446) (4,054) (850) (2,369) (9,422) (7,046) (3,023) 1,992 2,676 (5,401) (1,712) (3,017) 1,169 4,779 1,219 EBITDA Margins n/a -42.2% -20.0% -93.8% -80.1% -9.9% -3.6% -6.0% -6.6% -1.2% -3.1% -3.6% -9.5% -3.8% 2.3% 2.7% -1.6% -1.7% -2.9% 1.1% 3.9% 0.3% Proforma Income Before Taxes (6,609) (9,089) (5,815) (10,377) (12,654) (15,784) (11,874) (4,903) (5,660) (2,029) (3,539) (16,131) (8,977) (5,660) (738) (102) (15,477) (4,516) (6,045) (2,049) 1,264 (11,345) Income Tax Reported Tax Rate % -0.3% -0.7% -1.2% -1.3% -1.4% -1.1% -5.2% -3.1% -3.5% -8.8% -9.2% -5.3% -3.1% -3.5% -27.1% % -5.7% -4.4% -3.3% -9.8% 15.8% -7.1% Proforma Net Income (loss) (6,629) (9,151) (5,887) (10,514) (12,835) (15,959) (12,488) (5,056) (5,860) (2,207) (3,863) (16,986) (9,255) (5,860) (938) (302) (16,355) (4,716) (6,245) (2,249) 1,064 (12,145) Proforma Net Margin -60.4% -46.6% -20.1% -22.6% -17.0% -13.4% -6.7% -8.8% -9.5% -3.2% -5.0% -6.4% -12.4% -7.3% -1.1% -0.3% -4.8% -4.8% -6.1% -2.1% 0.9% -2.8% GAAP Pre-Tax Income (6,829) (10,121) (8,293) (48,998) (69,206) (31,432) (40,554) (15,637) (16,432) (14,133) (17,842) (62,747) (22,984) (20,010) (15,213) (14,752) (72,959) (19,366) (21,420) (17,949) (15,161) (73,895) Income Tax Tax Rate % -0.3% -0.6% -0.9% -0.3% -0.3% -0.6% -1.5% -1.0% -1.2% -1.3% -1.8% -1.4% -1.2% -1.0% -1.3% -1.4% -1.2% -1.0% -0.9% -1.1% -1.3% -1.1% GAAP Net income (loss) (6,849) (10,183) (8,365) (49,135) (69,387) (31,607) (41,168) (15,790) (16,632) (14,311) (18,166) (63,602) (23,262) (20,210) (15,413) (14,952) (73,837) (19,566) (21,620) (18,149) (15,361) (74,695) GAAP Net margin -62.4% -51.9% -28.5% % -91.9% -26.5% -22.2% -27.5% -27.1% -20.9% -23.6% -24.1% -31.3% -25.2% -17.6% -15.3% -21.7% -19.9% -21.1% -16.6% -12.6% -17.3% Proforma EPS $ (0.77) $ (1.09) $ (0.70) $ (0.32) $ (0.32) $ (0.32) $ (0.24) $ (0.10) $ (0.11) $ (0.04) $ (0.07) $ (0.32) $ (0.17) $ (0.11) $ (0.02) $ (0.01) $ (0.30) $ (0.09) $ (0.11) $ (0.04) $ 0.02 $ (0.22) Y/Y Growth % 153.7% 40.9% -36.3% -54.1% 1.0% -0.9% -24.0% -8.5% 59.6% 10.6% 120.1% 31.3% 79.1% -1.6% -58.2% -92.3% -5.4% -49.8% 5.0% 136.4% % -26.8% GAAP EPS $ (0.80) $ (1.21) $ (0.99) $ (5.34) $ (1.74) $ (0.63) $ (0.80) $ (0.30) $ (0.31) $ (0.27) $ (0.34) $ (1.19) $ (0.43) $ (0.37) $ (0.28) $ (0.27) $ (1.36) $ (0.36) $ (0.39) $ (0.33) $ (0.28) $ (1.36) Y/Y Growth % n/a 51.8% -18.6% 440.2% -67.4% -63.7% 26.5% 53.1% 84.2% 24.9% 64.3% 49.2% 44.2% 19.5% 6.0% -18.9% 14.1% -17.1% 5.4% 16.0% 1.2% -0.3% Basic Shares Oustanding ,206 39,824 49,949 51,420 52,726 53,197 53,423 53,660 53,252 53,876 54,076 54,276 54,476 54,176 54,676 54,876 55,076 55,276 54,976 Fully Diluted Share Outstanding 39,824 49,949 51,420 52,726 53,197 53,423 53,660 53,252 53,876 54,076 54,276 54,476 54,176 54,676 54,876 55,076 55,276 54,976 Deferred Revenue - 14, , , , , ,856 CFO - (5,986) (1,633) 1,705 1,832 10,295 17, (8,157) (4,153) 44,440 33,009 (2,650) Cash Balance - 3,290 8, , , , , ,687 Cash/Share n/a n/a n/a Scott Berg, Source: Company Reports and Needham & Company Estimates $ in thousands, except per share data Needham & Company, LLC Page 22 of 75

23 Figure 14 Cornerstone OnDemand Balance Sheet Balance Sheet Q 2Q 3Q 4Q Q 2QE 3QE 4QE 2015E 1QE 2QE 3QE 4QE 2016E Assets Cash and equivalents 85,409 76, , ,685 96, , , ,557 86,648 70,059 65, , , ,041 83,037 85, , ,800 Short Term Investments 199, , , , , , , , , , , , , , , ,449 Accounts receivables 34,110 47,528 67,191 52,545 69,128 86,856 84,499 84,499 61,392 92, , , ,450 90, , , , ,404 Deferred Commissions 3,537 9,354 16,634 15,947 19,047 20,004 26,236 26,236 24,758 24,028 25,360 29,271 29,271 27,511 27,680 29,513 32,930 32,930 Prepaid expenses and other assets 3,789 8,249 14,118 11,890 12,690 13,568 13,007 13,007 15,785 13,616 13,992 15,611 15,611 17,686 17,428 17,489 19,514 19,514 Total Current Assets 126, , , , , , , , , , , , , , , , , ,098 Capitalized software development costs 4,106 7,007 10,665 11,732 13,088 14,357 15,719 15,719 17,245 17,126 17,024 16,935 16,935 17,858 18,657 19,348 19,878 19,878 Total PP&E 3,663 7,947 14,436 17,333 19,376 20,428 21,424 21,424 23,101 22,982 22,880 22,791 22,791 23,714 24,513 25,704 27,234 27,234 Long term investments - 16,029 54,263 59,883 3,938 3,938 53,590 53,590 53,590 53,590 53,590 53,590 53,590 53,590 53,590 53,590 Intangible assets, net 6,887 4,632 4,068 3,543 3,019 27,282 27,282 24,639 25,182 22,539 23,082 23,082 20,982 20,982 18,882 18,882 18,882 Goodwill 8,193 8,193 8,193 8,193 8,193 25,894 25,894 25,894 25,894 25,894 25,894 25,894 25,894 25,894 25,894 25,894 25,894 Deferred offerings costs Other assets ,978 5,675 5,373 5,227 4,993 4,993 5,124 4,806 5,247 5,854 5,854 5,895 6,151 6,559 7,318 7,318 Total Assets 135, , , , , , , , , , , , , , , , , ,893 Liabilities and Equity Accounts payable 3,834 4,849 10,037 12,293 12,932 11,551 16,737 16,737 12,660 16,819 14,866 19,514 19,514 21,616 21,529 18,582 24,393 24,393 Accrued expenses and other curr. Liab. 8,039 14,986 22,288 16,603 21,862 22,377 29,476 29,476 22,156 28,032 28,858 37,077 37,077 27,511 35,882 36,072 46,346 46,346 Current portion of deferred revenues 52,338 87, , , , , , , , , , , , , , , , ,813 Capital lease obligations, current 1,617 1, ,702 1,702 1,702 1,702 1,702 Debt, current Other liabilities 1,261 3,885 4,203 1,019 1,288 2,258 3,052 3,052 2,594 8,009 8,745 9,757 9,757 11,791 12,302 13,117 14,636 14,636 Total current liabilities 67, , , , , , , , , , , , , , , , , ,118 Other liabilities 806 3,592 3,111 3,427 3,815 4,036 3,871 3,871 3,588 3,588 3,588 3,588 3,588 3,588 3,588 3,588 3,588 3,588 Deferred revenue, net of current portion 3,542 4,493 3,500 1,846 3,565 5,410 10,738 10,738 12,504 12,504 12,504 12,504 12,504 12,504 12,504 12,504 12,504 12,504 Convertible notes, net 217, , , , , , , , , , , , , , , ,094 Capital Lease obligations, net of current 1,056 1, (100) (200) (300) (400) (400) (500) (600) (700) (800) (800) Long term debt, net of current 409 1, Preferred stock warrant liabilities Total liabilities 72, , , , , , , , , , , , , , , , , ,504 Total stockholders' equity 62,460 46,648 52,895 50,814 44,133 41,447 35,502 35,502 24,408 16,422 11,083 9,832 9,832 (504) (8,493) (14,435) (14,611) (14,611) Total Liabilities and Equity 135, , , , , , , , , , , , , , , , , ,893 Scott Berg, Source: Company Reports and Needham & Company Estimates $ in thousands, except per share data Needham & Company, LLC Page 23 of 75

24 Figure 15 Cornerstone OnDemand Statement of Cash Flows Cash Flows Q 2Q 3Q 4Q QE 2QE 3QE 4QE 2015E 1QE 2QE 3QE 4QE 2016E Operating activities Net income (loss) (8,392) (52,187) (63,900) (31,390) (40,426) (15,790) (16,632) (14,311) (18,166) (64,899) (23,262) (20,210) (15,413) (14,952) (73,837) (19,566) (21,620) (18,149) (15,361) (74,695) Depreciation and amortization 1,286 3,179 3,714 7,037 9,700 3,072 3,213 3,546 5,255 15,086 6,228 6,237 6,205 6,178 24,848 6,154 6,403 6,618 6,940 26,115 Non-cash interest expense ,559 2,031 2,055 2,081 2,107 8,274 2,133 2,150 2,175 2,200 8,658 2,250 2,275 2,300 2,325 9,150 Accrection of debt discount and amortization of debt issuance costs Purchase investment premium, net of amortization (2,031) 926 (269) (432) (65) Change in fair value of preffered stock warrart liabilities 2,147 35,345 45, Unrealized foreign exchange loss 19 (44) (129) 264 1, ,656 1,887 Charges related to the issuance of a common stock warrant 2,877 - (201) Stock-based compensation 331 1,002 4,502 12,206 20,840 7,892 8,134 8,478 9,176 33,680 8,717 9,750 10,000 10,250 38,717 10,500 11,000 11,500 12,000 45,000 Deferred income tax (1,050) (865) (7) (7) Non-cash charitable contribution of stock Loss on disposal of fixed assets 47 1, Changes in operating assets and liabilities - Accounts receivables (3,272) (4,198) (13,435) (12,254) (19,046) 14,897 (16,162) (19,655) 2,246 (18,674) 21,356 (30,715) (12,830) 2,486 (19,702) 12,056 (22,377) (7,469) (4,164) (21,954) Deferred Commissions (881) (1,365) (1,274) (5,691) (7,085) 741 (2,912) (1,356) (6,570) (10,097) (1,332) (3,912) (3,539) 1,760 (169) (1,833) (3,417) (3,659) Prepaid expenses and other assets (282) (1,456) (1,804) (4,188) (6,057) 2,504 (598) (1,061) 400 1,245 (3,515) 2,169 (376) (1,620) (3,341) (2,074) 258 (61) (2,025) (3,903) Accounts payable 468 2, ,082 1,088 1,549 (600) 2,525 4,562 (2,362) 4,159 (1,953) 4,648 4,492 2,102 (87) (2,946) 5,810 4,879 Accrued expenses and other current liabilities 1, ,314 6,325 6,828 (5,401) 4, ,321 6,446 (6,954) 5, ,220 7,967 (9,566) 8, ,275 9,269 Deferred revenue 5,146 13,878 22,161 35,327 45,230 (8,080) 7,624 16,120 39,552 55,216 (7,104) 3,848 13,188 43,905 53,837 (3,309) (5,569) 20,064 58,334 69,520 Other Liabilities 24 1, , (2,872) 649 1, (295) (683) 5, ,012 6,480 2, ,519 4,879 Net Cash provided by (used in) operating activities (1,633) 1,705 1,832 10,295 17, (8,157) (4,153) 44,440 33,009 (2,650) (10,589) 1,225 58,416 44,580 2,341 (21,004) 11,028 72,235 64,600 operating cash flow margin -5.6% 3.7% 2.4% 8.6% 9.4% 1.5% -13.3% -6.1% 57.8% 12.5% -3.6% -13.2% 1.4% 59.9% 13.1% 2.4% -20.5% 10.1% 59.2% 15.0% Investing Activities Purchase of investment securities (203,959) (17,504) (65,171) (41,516) (124,191) (81,497) Maturities and sales of investment securities 6,182 16,012 66,243 57,594 63, ,078 14,497 Purchase of PP&E (76) (1,106) (848) (2,123) (8,762) (3,196) (4,073) (3,253) (503) (11,025) (5,064) (3,000) (3,000) (3,000) (14,064) (4,000) (4,000) (4,500) (5,000) (17,500) Capitalized software costs (1,495) (2,242) (2,958) (5,030) (6,906) (2,349) (2,314) (2,337) (2,529) (9,529) (3,471) (3,000) (3,000) (3,000) (12,471) (4,000) (4,000) (4,000) (4,000) (16,000) Cash paid for acquisitions (12,428) (43,328) (43,328) Purchases of intangible assets (28) (202) (79) Net cash provided by (used in) investing activities (1,599) (3,550) (3,885) (19,581) (213,445) (7,037) (5,315) 10,488 16,869 15,005 (75,535) (6,000) (6,000) (6,000) (26,535) (8,000) (8,000) (8,500) (9,000) (33,500) Free Cash Flow (FCF) (3,204) (1,643) (1,974) 3,142 1,763 (4,666) (14,544) (9,743) 41,408 12,455 (11,185) (16,589) (4,775) 52,416 18,045 (5,659) (29,004) 2,528 63,235 31,100 Unlevered FCF (4,699) (3,885) (4,932) (1,888) (5,143) (7,015) (16,858) (12,080) 38,879 2,926 (14,656) (19,589) (7,775) 49,416 5,574 (9,659) (33,004) (1,472) 59,235 15,100 ufcf margins -16.0% -8.3% -6.5% -1.6% -2.8% -12.2% -27.4% -17.7% 50.6% 1.1% -19.7% -24.5% -8.9% 50.6% 1.6% -9.8% -32.2% -1.3% 48.6% 3.5% Financing Activities Proceeds from the issuance of debt 3,947 20,700 (587) 1, , Proceeds from the issuance of preferred stock 8,700-3, Proceeds from the issuance of warrants 23,225 Issuance costs of preferred stock (32) Payments for convertible note hedges (49,537) Proceeds from initial public offering 90, Repayment of debt (4,300) (18,861) (9,207) (1,510) (4,038) (139) (142) (144) (134) (559) (124) (124) - Principal payments under capital lease obligations (322) (1,537) (1,977) (1,919) (1,747) (318) (200) (183) (185) (886) (95) (95) - Payments of IPO costs (250) (2,735) Proceeds from stock option and warrant exercises ,443 2,697 13,447 5,609 1,729 2,383 2,564 12,285 1,383 1,383 - Net cash provided by (used in) financing activities 8, , ,928 5,152 1,387 2,056 2,245 10,840 1, , Effects of exchange rates (244) (22) (975) (991) (1,880) (2,888) (2,888) - Net Increase (decrease) in cash and cash equivalents 4,771 (885) 78,342 (8,967) 33,141 (898) (12,107) 7,416 62,563 56,974 (79,909) (16,589) (4,775) 52,416 16,321 (5,659) (29,004) 2,528 63,235 31,100 Cash and equivalents at beginning of period 3,290 8,061 7,076 85,409 76, , ,685 96, , , ,557 86,648 70,059 65, , , ,041 83,037 85, ,878 Cash and equivalents at end of period 8,061 7,076 85,409 76, , ,685 96, , , ,557 86,648 70,059 65, , , ,041 83,037 85, , ,978 Scott Berg, Source: Company Reports and Needham & Company Estimates $ in thousands, except per share data Needham & Company, LLC Page 24 of 75

25 Healthstream (HSTM) Talent Management Does Healthcare; Initiating w/ Buy Rating, $33PT Investment Thesis We are initiating coverage on HSTM with a Buy rating and a $33 price target. We believe HealthStream uniquely benefits from two significant mega-trends: 1) the strong secular adoption rates within the Talent Management Enterprise Software subsector, and also 2) an increasingly more regulated environment, requiring its products end users to evaluate competencies and train employees on a more frequent basis. We believe the combination of these two industry mega-trends is likely to further drive sales for a multi-year period. We believe the greatest near-term risk to be purely execution related, and we therefore see a positive risk/reward scenario for investors. We believe what differentiates the HealthStream investment thesis from other Talent Management software companies in our current universe is the company s vertical approach to combining software platform, content and services together as a more complete workforce management offering. Our research in the space with companies like Kenexa (IBM not rated) has shown accelerating adoption rates for the vertical solutions, and we believe HealthStream can similarly benefit. Investment positives Talent Management Remains a Top 2 Priority Among Corporate Executives. We continue to be in favor of significant exposure to Talent Management software companies given the current elevated level of executive emphasis on workforce management. Numerous studies consistently show workforce management as a Top 2 management priority, and while much of the training in a patient care setting is viewed as regulatory driven, our research indicates that this overall workforce management emphasis holds true within the greater healthcare sector. We believe HealthStream s sales should continue to benefit from this management focus as customers purchase Talent Management solutions to improve their workforce management. Highly regulated environment drives training, competency requirements. Essentially all positions involved with patient care require periodic and recurring training or skills assessment. We believe this continuing education regulatory requirement drives recurring spend for software and content to satisfy these requirements, which should supply ample demand for HealthStream s industryleading solutions. Demand for HCM vertical solutions remains high as customers seek more streamlined integrations. Our prior research within the Human Capital Management (HCM) industry indicates customers are increasingly selecting vendors with a broader base of solutions to reduce the number of complex integrations that are often required to manage their respective workforces. While this approach has frequently represented a more horizontal approach to consolidating software infrastructure, we have seen an increasing demand for vertically connected software and content to deliver a more holistic solution for workforce management. Our HealthStream customer conversations support this thesis and indicate that this adoption trend is highly sustainable. Large upsell opportunity to further drive strong ARPU Growth. We believe the company partially benefits from a razor/razor blade model which could further drive Page 25 of 75

26 significant ARPU growth, or what the company calls Annualized Revenue per Implemented Subscriber. While not all of its customers purchase its core technology, the majority do, and we believe those customers are much more likely to purchase required regulatory content and surveys from HealthStream. ARPU has grown 51% since 4Q11 to $34.63 and we believe ARPU can grow at a normalized rate of greater than 10% annually for several years. We prefer subscription-based revenue models given better visibility. We prefer the SaaS delivery model in general to on-premise, perpetual-license software delivery models because the SaaS model delivers more predictable near-term revenue and cash flows while also being more profitable over the long term. We believe this model, when combined with the company s high renewal rates, gives investors a higher level of visibility into the company s near-term financials versus a perpetual license model. Investment Concerns Implementation of ICD-10 creates FY16 revenue headwind. The regulation requiring adoption of ICD-10 (International Statistical Classification of Diseases and Related Health Problems, version 10) by U.S. healthcare entities before October 1, 2015, has driven elevated levels of content sales for HealthStream over the past two years. Once fully implemented late this year, customers will likely reduce their need for ICD-10 training as mass training initiatives are replaced by smaller efforts to train new staff or simply to maintain existing competencies. We believe this spend reduction could create a revenue headwind in 2016 of up to $10MM. Finite market opportunity limits long-term potential. While we believe the company has a significant growth opportunity over the next five to seven years, it currently enjoys a roughly 55% penetration rate among potential end users, or 4.4MM of its target 8MM domestic U.S. addressable market. Given this relatively deep user penetration rate, we envision a growth scenario several years out that is more dependent on ARPU growth than unit growth as unit penetration eclipses 70%. Although the company s ARPU growth has been exceptionally strong as of late, we view ARPU growth as more difficult than unit growth over the long term. Human Capital Management market highly competitive. The Talent Management (TM) industry is extremely fragmented and highly competitive at all customer segment levels. While we believe Healthstream s integrated suite of TM applications offers a unique and highly in-demand vertical value proposition, the company does compete against many larger and better capitalized competitors that could exert pricing pressure. We expect this market to remain highly competitive over the near term, requiring Healthstream to maintain innovative product development and competitive pricing. Valuation We derive our $33 price target for HealthStream using an EV/revenue valuation methodology as we believe this methodology allows for consistent comparison across Software-as-a-Service (SaaS) companies. SaaS companies like HealthStream have historically traded at 2-8x forward-year revenue multiples, and we believe HealthStream should be trading in line with the median valuation in this range given its growth rate, which faces a significant headwind from lost ICD-10 revenues over the next two years. At 3.8x our FY16 revenue estimate of $233MM, we arrive at an Enterprise Value of $885MM. After adding in $36MM in net cash, we believe the company should have a market value of $921MM, or $33 per share. Company Overview HealthStream, Inc. provides Internet-based learning, talent management, and research solutions for healthcare organizations all designed to hire, assess, and Page 26 of 75

27 develop the employees that deliver patient care, which ultimately supports the improvement of business and clinical outcomes. The company s learning and talent management products include software and content used by healthcare organizations to meet training, certification, competency assessment, performance appraisal, and development needs, while its research products survey patients on perception of care quality and patient experiences with staff and facilities for customers. Current customers number over 3,000 and include healthcare organizations, pharmaceutical and medical device companies, and other participants in the healthcare industry throughout the United States. HealthStream is headquartered in Nashville, TN and has roughly 674 employees as of December 31st, HealthStream has raised $109.11MM in total net proceeds to date. The company raised $11.3MM through pre-ipo private funding, $45.0MM from its April 2000 IPO, and $52.81MM from its November 2011 secondary offering. Given the company currently has $101MM in net cash, we do not foresee the company raising additional funds to finance operations or acquisitions in the near term. HealthStream s acquisition strategy since 1999 has focused on product acquisitions that complement its existing solutions sets. We believe the company s acquisition strategy has predominately centered on horizontally expanding its product offering to further expand its suite of solutions. We believe the company will continue to execute one to two similarly sized acquisitions annually of $5-10MM for both services and software product offerings. Exhibit #16 below details the company s acquisitions since Figure 16 Healthstream Acquisition History Date Name Price Product description Feb HealthLine Systems $88mm Developer of softwar eproducts used to credential healthcare professionals. Mar Health Care Compliance Strategies 15.mm Provider of healthcare compliance courseware and training programs. Sept Baptist Leadership Group $8.5mm Provided custom, individualized coaching that produced measureable, sustainable increases in patient satisfaction, employee engagement, quality outcomes, and profitability through a comprehensive suite of assessment tools. Oct Sy.Med Development, Inc. $7.1mm Specialized in credentialing related software products for healthcare providers. Jun Decision Critical Inc. $3.4mm Specialized in learning and competency management products for acute-care hospitals. Mar The Jackson Organization $12.6mm Provided healthcare organizations with quality and satisfaction surveys, data analyses of survey results, and other research-based measurement tools. Mar Data Management & Research Inc. $10.7mm Provided healthcare organizations a wide range of quality and satisfaction surveys, data analyses of survey results, and other research-based measurement tools focused on physicians, patients, and employees. Jan de 'MEDICI Systems $330k Provided computer based education and training to over 230 hospitals and healthcare organizations. Sept SynQuest $2.3mm Provided online training and education to hospitals and healthcare organizations. The SynQuest business generates installed learning management product and Internetbased e-learning revenues. Jul Education Design $3.0mm Provided services for live educational events that are supported by the medical device industry. The EDI business generates live event development, coordination, and registration revenues. Jan Emergency Medicine Internetwork $600k Sold online medical education content to emergency medical services personnel. The EMInet business generates revenues related to sales of subscription products. Jan Multimedia Marketing, Inc. $600k Provided interactive, multimedia education and training solutions to hospitals and other healthcare organizations. The m3 business generates installed learning management product and Internet-based e-learning revenues. Jan Quick Study, Inc. $100k Published CD-ROM and network-based products for the healthcare industry. The Quick Study business generates installed learning management product and Internetbased e-learning product revenues. Jul KnowledgeReview, LLC $300k Owned and operated an Internet Web page that provided a search engine (CMEsearch.com) that helped physicians locate continuing medical education by specialty and facilitated online registration for such courses. Jul SilverPlatter Education, Inc. $800k Provided CD-ROM and Internet-based continuing medical education programs to physicians. Total: $153.53mm Source: Company reports HealthStream s primary go-to-market strategy utilizes a direct sales model given the specialty focus of its product offerings. The company has an extensive partner ecosystem numbering 130 partners predominately for content and simulation equipment, but no current structured channel partner distribution efforts. Page 27 of 75

28 HealthStream s Niche Within HCM HealthStream is unique within the HCM vendor landscape as its solutions only target healthcare organizations for Acute-care and Post-acute care in the U.S. The company believes this domestic target market represents roughly 8MM professionals today. Although the company does not disclose the total potential spend for a target employee, we believe this spend could be $ annually including content and assessments, which implies a minimum market size of roughly $ B. HealthStream Products HealthStream takes a more solution-focused approached within its product set, offering its healthcare customers a broad set of content, data, and research services to go along with a robust Talent Management software platform. All current applications are delivered via a Cloud-based, Software-as-a-Service platform. The central theme around their products is the focus on creating a complete verticalized solution for healthcare industry-specific needs. Figure 17 The Healthstream Solution Source: Company data, Needham & Company, LLC ` We believe what differentiates HealthStream s products most versus potential competitors is its solution-based focus on not just providing technology, but also providing the content, assessments, and research services required to more completely develop a customer s workforce. We believe customers prefer this onestop shop approach given the lack of integration required when alternatively buying best-of-breed across these product areas. Our prior research in the Talent Management space indicates customers are increasingly trying more solution-based approaches to Talent Management purchases versus a best-of-breed approach. We believe adoption for this vertical approach is trending well, given the platform has 4.4MM subscribers out of a possible 8MM. Exhibit #18 below shows quarterly subscriber growth since 2003 while Exhibit #19 details quarterly subscriber additions. Page 28 of 75

29 Figure 18 Figure 19 5,000,000 4,500,000 4,000,000 3,500,000 3,000,000 2,500, , , , ,000 2,000,000 1,500, ,000 1,000, ,000-1Q 03 1Q 04 1Q 05 1Q 06 1Q 07 1Q 08 1Q 09 1Q 10 1Q 11 1Q 12 1Q 13 1Q14 1Q15 Source: Company data, Needham and Company LLC 50,000-1Q 03 1Q 04 1Q 05 1Q 06 1Q 07 1Q 08 1Q 09 1Q 10 1Q 11 1Q 12 1Q 13 1Q14 1Q15 Source: Company data, Needham and Company LLC Technology: All of HealthStream s software platform is developed using a Microsoft.NET, service-orientated architecture infrastructure. Mobile Strategy: The company currently has a limited mobile strategy with functionality limited to an iphone/ipad app for Hospital Consumer Assessment of Healthcare Providers and Systems (HCAHPS) surveys. Expansion plans for this strategy are currently in development. HealthStream s current product portfolio includes: HealthStream Performance Center: Purpose-built for the healthcare industry, the HealthStream Performance Center automates the administration of the performance management process, including performance appraisal and goals management applications. HealthStream Competency Center: The HealthStream Competency Center offers a library containing over 2,200 clinical and non-clinical competencies. The product offers a way to properly assess, scale, and collaborate in assessing and improving core competencies. HealthStream Learning Center: The HealthStream Learning Center is a traditional Learning Management System purpose-built for the healthcare industry. The HLC also contains a rich set of third-party course content with more than 6,000 courses to create a more complete learning solution. HealthStream Simulation: The HealthStream SimCenter enables users the ability to simulate the delivery of patient care through the use of simulators, video & data capturing, and scenario-based training. SimCenter combines curriculum delivery, learning management, debriefing, and competency assessment to both new and current employees to aid in both quality of care and regulation requirements. Page 29 of 75

30 Figure 20 HealthStream SimCenter Source: Company data, Needham & Company, LLC Healthstream Recruiting: Healthstream recently released a Recruiting solution during the first quarter of While too early to gauge its potential success, the application s value proposition lies in its ability to tie together vertical-specific functionality around assessing potential candidates. HealthStream Research: Research and consulting services are offered to hospitals to drive improved clinical and business outcomes, more efficient treatment, and overall sustainable improvement. The company s telephony-based and computerbased surveys exceed government mandated requirements for patient surveys but also measure employee and physician engagement. The company s consulting services assist customers with interpreting survey data and identify improvement opportunities. HealthStream People: Robert A. Frist, Jr. Chairman, President, & CEO (co-founder) Robert A. Frist, Jr., co-founder, has served as chief executive officer, president, and chairman of the board of directors since He is a board member at Nashville's Adventure Science Center, the Minnie Pearl Cancer Foundation, and co-founder and board member of Nashville's Entrepreneur Center. He graduated with a Bachelor of Science in business from Trinity University. Gerard M. Hayden Chief Financial Officer & SVP Gerard M. Hayden, Jr. joined as senior vice president and chief financial officer (CFO) in mid-may 2008 after resigning from HealthStream's Board of Directors, where he had been a Member since Most recently serving as chief financial officer for MedAvant Healthcare Solutions, Mr. Hayden has additional experience serving as chief financial officer for such companies as Private Business, Inc., Covation, Meridian Occupational Healthcare Associates, Inc., ENVOY (now part of WebMD), and Allied Clinical Laboratories, Inc. Mr. Hayden holds a Bachelor of Arts in Government and Page 30 of 75

31 International Studies from the University of Notre Dame and a Master of Science in Accounting from Northeastern University. J. Edward Pearson Chief Operating Officer & SVP J. Edward Pearson has served as senior vice president since he joined HealthStream in June 2006, and was named chief operating officer in August Prior to his current position, he served as president and chief executive officer of DigiScript, Inc. Mr. Pearson's tenure in e-healthcare also includes serving as CFO and executive vice president of Inforum, Inc., CFO of HIE, Inc., CEO of empacthealth.com, and CTO and, subsequently, CEO of Medibuy. Starting his career with a Bachelor's Degree of Business Administration from Middle Tennessee State University, Mr. Pearson first worked at William Puryear & Company, a public accounting firm, as a CPA. Jeffrey S. Doster Chief Technology Officer & SVP Jeffrey Doster joined as senior vice president and chief technology officer (CTO) in mid-may Mr. Doster has held several senior information technology (IT) positions, including senior vice president and chief technology officer at The Shop at Home Network, LLC and senior vice president of IT at New Roads, Inc. Mr. Doster earned undergraduate degrees in both Economics and Business Administration from Towson University, as well as a Masters of Business Administration from Loyola College in Baltimore, Maryland. Financials We have modeled our HealthStream estimates based on several assumptions. These include: The company recognizes roughly 80% of its revenues ratably over the term of their respective subscription contracts. Revenues from the company s survey and research services are recognized primarily upon delivery of survey or research results. The company s Non-GAAP adjustments differ from the remainder of our software coverage only adding back the negative impact due to writing down deferred revenues for purchase accounting but not adjusting out the impact of Amortization of Acquired Intangibles or Share-Based Compensation. As a result, the company s Non-GAAP earnings are not comparable to earnings within our other software coverage. We expect FY15 Y/Y growth in the company s research segment to be limited given the loss of a large customer whose contract ended in 1Q15. The company s recent acquisition of HealthLine systems will be dilutive to 2015 GAAP EPS primarily from the write-down of deferred revenue due to purchasing accounting. We expect this acquisition will be accretive to net income upon anniversary of the acquisition s closing date. Income Statement Overview We expect HealthStream to generate FY15 total revenues of $205.1MM, a 20.2% Y/Y increase. We expect revenues associated with the company s Learning and Talent Management platform to grow 16.5% Y/Y to $100.2MM while modeling revenues from its research division to grow 1.4% to $32.3MM. We estimate gross margins will compress 30 bps Y/Y to 56.3%, primarily due to the writedown of deferred revenues. Our GAAP operating margin estimate of 6.0% is 360 bps lower Y/Y, primarily a result of this acquisition dynamic. We are modeling a 40.5% Y/Y decrease in GAAP EPS to $0.22. Page 31 of 75

32 Figure 21 HSTM Revenues vs. Operating Margins millions $250.0 $232.9 $200.0 $205.1 $150.0 $170.7 $132.3 $100.0 $103.7 $82.1 $50.0 $57.4 $65.8 $ E 2016E Source: Company reports and Needham & Company, LLC estimates 50.0% 45.0% 40.0% 35.0% 30.0% 25.0% 20.0% 15.0% 10.0% 5.0% 0.0% Total revenues Operating Margin Learning and Talent Management Platform Revenues HealthStream s Learning and Talent Management platform revenues as a percent of its total revenues have grown faster than overall revenues. In 2009, these platform revenues comprised $38MM, or 66.5% of total revenues, but have increased to $139MM in 2014 and comprise 80% of total revenues. We estimate that these revenues will continue to grow faster than professional services and that they will comprise 85% of total FY16 revenues. Figure 22 HSTM LMS/TM Platform Revenues as a Percent of Total Revenues $240.0 $ % 68.7% 70.8% 75.7% 78.5% 81.3% 83.3% 84.6% 90.0% 80.0% 70.0% 60.0% millions $140.0 $90.0 $40.0 $38.2 $45.2 $58.1 $78.6 $103.9 $138.8 $161.6 $ % 40.0% 30.0% 20.0% 10.0% 0.0% Research LMS and TM % of total ($10.0) E 2016E Source: Company reports and Needham & Company, LLC estimates -10.0% Cash Flows Healthstream is not a capital-intensive business, requiring little working capital. The majority of its CapEx charges are related to the company s SaaS platform. We believe FY15 operating cash flow margins of 14.8% will remain pressured vs. 20.1% in 2014, resulting from purchase accounting. We are estimating a total of $13.3MM in CapEx (versus $10.2MM in 2014), which includes $6.5MM from Capitalized Software. We are modeling 2015 CapEx of $14MM. Figure 23 HSTM Cash Flow Estimates E 2016E Operating cash flows $16,149 $19,757 $22,513 $26,283 $34,256 $30,393 $44,098 OCF Margins 24.6% 24.1% 21.7% 19.9% 20.1% 14.8% 18.9% Free Cash Flow $13,525 $15,642 $18,197 $21,839 $29,712 $23,580 $37,098 FCF margins 17.5% 11.7% 13.3% 13.3% 14.1% 8.3% 12.9% Source: Company reports and Needham & Company, LLC estimates Page 32 of 75

33 Balance Sheet Healthstream has a relatively clean balance sheet with net cash of $36.4MM as of March 31, However, we note several items: DSOs: 1Q15 DSOs of 70 days are essentially flat Y/Y from 71 days in 1Q14. We are modeling DSOs to be in line with recent historical trends of days. Goodwill and intangible assets: The company has Goodwill and intangible assets totaling $145.4MM. The company has been amortizing roughly $800k quarterly of intangibles. We do not expect any impairment to goodwill in the near or medium term. Deferred revenues: Total deferred revenues of $66.5MM are 40.1% higher Y/Y, and have accelerated over the past 18 months with the addition of the company s ICD-10 content. However, we do not believe growth in deferred revenues to be truly representative of revenue growth given the company s billing policies for content, surveys, and research. Page 33 of 75

34 Figure 24 HealthStream Income Statement Income Statement Q 2Q 3Q 4Q Q 2QE 3QE 4QE 2015E 1QE 2QE 3QE 4QE 2016E Revenues 51,600 57,398 65,753 82, , ,274 38,350 42,476 44,525 45, ,690 47,156 49,628 53,286 55, ,143 56,312 57,738 58,821 60, ,903 Y/Y Growth 14.6% 24.8% 26.4% 27.5% 29.4% 33.1% 32.3% 22.4% 29.0% 23.0% 16.8% 19.7% 21.5% 20.2% 19.4% 16.3% 10.4% 9.0% 13.5% Q/Q Growth 3.5% 10.8% 4.8% 1.8% 4.0% 5.2% 7.4% 3.4% 2.2% 2.5% 1.9% 2.1% Cost of Revenues 19,653 21,343 24,190 31,066 41,658 55,606 16,926 18,738 19,115 19,367 74,146 20,193 22,829 23,179 23,406 89,607 23,369 23,673 23,822 24,013 94,877 % of Revenue 38.1% 37.2% 36.8% 37.9% 40.2% 42.0% 44.1% 44.1% 42.9% 42.7% 43.4% 42.8% 46.0% 43.5% 42.5% 43.7% 41.5% 41.0% 40.5% 40.0% 40.7% Gross Profit 31,947 36,055 41,563 51,000 62,075 76,668 21,424 23,738 25,410 25,972 96,544 26,963 26,799 30,106 31, ,536 32,942 34,065 34,998 36, ,026 Gross Margins as a Percentage 61.9% 62.8% 63.2% 62.1% 59.8% 58.0% 55.9% 55.9% 57.1% 57.3% 56.6% 57.2% 54.0% 56.5% 57.5% 56.3% 58.5% 59.0% 59.5% 60.0% 59.3% Operating Expenses Product Development 5,670 6,285 6,989 7,472 8,611 11,756 3,546 4,294 4,211 4,411 16,462 4,646 5,211 5,861 6,609 22,327 6,757 6,813 6,882 6,964 27,416 % of Revenue 10.9% 10.6% 9.1% 8.3% 8.9% 9.2% 10.1% 9.5% 9.7% 9.6% 9.9% 10.5% 11.0% 12.0% 10.9% 12.0% 11.8% 11.7% 11.6% 11.8% Sales and Marketing 18,972 10,930 13,054 16,018 19,892 24,051 6,947 7,251 7,585 8,083 29,866 7,347 8,437 9,059 9,362 34,205 9,573 9,815 9,705 9,905 38,999 % of Revenue 19.0% 19.9% 19.5% 19.2% 18.2% 18.1% 17.1% 17.0% 17.8% 17.5% 15.6% 17.0% 17.0% 17.0% 16.7% 17.0% 17.0% 16.5% 16.5% 16.7% Other General and Administrative - 8,577 9,581 10,759 13,453 18,342 5,232 5,361 6,058 6,259 22,910 6,927 7,444 7,726 7,710 29,808 7,884 8,083 8,235 8,405 32,606 % of Revenue 14.9% 14.6% 13.1% 13.0% 13.9% 13.6% 12.6% 13.6% 13.8% 13.4% 14.7% 15.0% 14.5% 14.0% 14.5% 14.0% 14.0% 14.0% 14.0% 14.0% Depreciation and Amortization 4,822 5,139 4,880 5,413 6,660 7,852 2,401 2,722 2,815 2,993 10,931 3,253 4,471 4,615 4,651 16,989 4,671 4,421 4,490 4,587 18,169 % of Revenue 9.0% 7.4% 6.6% 6.4% 5.9% 6.3% 6.4% 6.3% 6.6% 6.4% 6.9% 9.5% 9.0% 8.6% 8.3% 8.3% 7.7% 7.6% 7.6% 7.8% Total Operating Expenses 29,464 30,931 34,504 39,662 48,616 62,001 18,126 19,628 20,669 21,746 80,169 22,173 25,563 27,261 28, ,330 28,885 29,133 29,313 29, ,191 Proforma Operating Income 2,483 5,124 7,059 11,338 13,954 15,505 3,667 4,813 4,891 4,470 17,841 5,368 4,737 5,045 4,335 19,484 4,635 4,933 5,686 6,159 21,412 Proforma Operating Margins 4.8% 8.9% 10.7% 13.8% 13.5% 11.7% 9.6% 11.3% 11.0% 9.9% 10.5% 11.4% 9.5% 9.5% 7.9% 9.5% 8.2% 8.5% 9.7% 10.3% 9.2% GAAP & Non Cash Expenses , ,500 2,200 1,000 7, GAAP Operating Income (Proforma less Def. Rev. Write Down) 2,483 5,124 7,059 11,338 13,459 14,667 3,298 4,110 4,741 4,226 16,375 4,790 1,237 2,845 3,335 12,206 4,057 4,933 5,686 6,159 20,834 GAAP Operating Margin 8.9% 10.7% 13.8% 13.0% 11.1% 8.6% 9.7% 10.6% 9.3% 9.6% 10.2% 2.5% 5.3% 6.1% 6.0% 7.2% 8.5% 9.7% 10.3% 8.9% Total Other Income (expense) (19) (420) (420) (420) (1,251) (420) (420) (420) (420) (1,680) Adjusted EBITDA 8,077 10,924 12,603 17,539 21,255 23,977 6,083 7,282 7,944 7,622 28,931 8,452 6,107 7,860 8,386 30,805 9,128 9,754 10,576 11,146 40,604 EBITDA Margins 19.0% 19.2% 21.4% 20.5% 18.1% 15.9% 17.1% 17.8% 16.8% 16.9% 17.9% 12.3% 14.8% 15.2% 15.0% 16.2% 16.9% 18.0% 18.6% 17.4% Proforma Income Before Taxes 2,555 5,109 7,040 11,348 14,072 15,681 3,712 4,836 4,940 4,499 17,987 5,377 4,317 4,625 3,915 18,233 4,215 4,513 5,266 5,739 19,732 Non-GAAP Taxes (301) (8,864) 2,885 4,403 6,156 6,781 1,549 2,070 1,396 1,700 6,715 2,327 1,856 1,989 1,683 7,855 1,812 1,940 2,264 2,468 8,485 Reported Tax Rate % -11.8% % 41.0% 38.8% 43.7% 43.2% 41.7% 42.8% 28.3% 37.8% 37.3% 43.3% 43.0% 43.0% 43.0% 43.1% 43.0% 43.0% 43.0% 43.0% 43.0% Proforma Net Income (loss) 2,856 13,973 4,155 6,945 7,916 8,900 2,163 2,766 3,544 2,799 11,272 3,050 2,460 2,636 2,231 10,378 2,402 2,572 3,002 3,271 11,247 Proforma Net Margin 6.3% 8.5% 7.6% 6.7% 5.6% 6.5% 8.0% 6.2% 6.6% 6.5% 5.0% 4.9% 4.1% 5.1% 4.3% 4.5% 5.1% 5.4% 4.8% GAAP Pre-Tax Income 2,555 5,109 7,040 11,348 13,577 14,843 3,343 4,133 4,790 4,255 16,521 4, ,425 2,915 10,955 3,637 4,513 5,266 5,739 19,154 Income Tax (301) (8,865) 2,885 4,403 5,932 6,424 1,395 1,769 1,354 1,608 6,126 2, ,043 1,253 4,724 1,564 1,940 2,264 2,468 8,236 Tax Rate % % 41.0% 38.8% 43.7% 43.3% 41.7% 42.8% 28.3% 37.8% 37.1% 43.3% 43.0% 43.0% 43.0% 43.1% 43.0% 43.0% 43.0% 43.0% 43.0% GAAP Net income (loss) 2,856 13,974 4,155 6,945 7,645 8,419 1,948 2,364 3,436 2,647 10,395 2, ,382 1,661 6,231 2,073 2,572 3,002 3,271 10,918 GAAP Net margin 24.3% 6.3% 8.5% 7.4% 6.4% 5.1% 5.6% 7.7% 5.8% 6.1% 5.8% 0.9% 2.6% 3.0% 3.0% 3.7% 4.5% 5.1% 5.4% 4.7% Proforma EPS $ 0.13 $ 0.64 $ 0.18 $ 0.29 $ 0.29 $ 0.32 $ 0.08 $ 0.10 $ 0.13 $ 0.10 $ 0.40 $ 0.11 $ 0.09 $ 0.09 $ 0.08 $ 0.37 $ 0.08 $ 0.09 $ 0.10 $ 0.11 $ 0.39 Y/Y Growth % 397.5% -71.1% 58.4% -1.7% 11.8% -0.8% 8.2% 46.4% 50.4% 25.0% 40.2% -11.4% -26.2% -21.0% -8.6% -22.3% 3.1% 12.3% 44.6% 6.9% GAAP EPS $ 0.13 $ 0.64 $ 0.18 $ 0.29 $ 0.28 $ 0.30 $ 0.07 $ 0.08 $ 0.12 $ 0.09 $ 0.37 $ 0.10 $ 0.02 $ 0.05 $ 0.06 $ 0.22 $ 0.07 $ 0.09 $ 0.10 $ 0.11 $ 0.38 Y/Y Growth % 397.5% -71.1% 58.4% -5.0% 9.5% -1.4% -3.8% 48.0% 49.1% 21.9% 38.9% -80.4% -60.1% -37.8% -40.5% -24.9% 444.9% 114.1% 94.2% 72.8% Fully Diluted Share Outstanding 22,204 21,838 22,488 23,727 27,507 27,663 27,906 28,043 28,047 28,095 28,023 28,068 28,168 28,268 28,368 28,218 28,468 28,568 28,668 28,768 28,618 Deferred Revenue 10,202 12,234 16,740 22,759 23,146 38,168 47,478 51,595 53,303 53,716 53,716 66,531 CFO 1,221 7,379 16,149 19,757 22,513 26,283 9,189 12,913 6,573 5,581 34,256 9,007 Cash Balance 4,107 12,287 23,707 83,456 93, , , , , , ,968 64,375 Cash/Share Scott Berg, Source: Company Reports and Needham & Company Estimates $ in thousands, except per share data Needham & Company, LLC Page 34 of 75

35 Figure 25 HealthStream Balance Sheet Balance Sheet Q 2Q 3Q 4Q Q 2QE 3QE 4QE 2015E 1Q 2QE 3QE 4QE 2016E Assets Cash and equivalents 18,004 76,904 41,365 59,537 59,045 60,862 64,927 81,995 81,995 34,764 37,753 42,863 47,153 47,153 53,420 67,844 72,367 77,254 77,254 Marketable Securities - Short Term 5,703 6,552 51,952 48,659 42,952 50,901 51,495 38,973 38,973 29,611 29,611 29,611 29,611 29,611 29,611 29,611 29,611 29,611 29,611 Accounts Receivable, net of allowance for doubtful accounts 12,383 17,330 16,511 26,706 33,500 31,882 30,115 34,845 34,845 37,032 32,258 36,234 39,653 39,653 47,865 37,530 39,998 43,223 43,223 Prepaid and Other Current Assets 4,744 5,213 6,004 12,222 14,754 16,736 16,398 18,798 18,798 23,329 19,851 21,314 22,029 22,029 22,525 23,095 23,528 24,013 24,013 Deferred Tax Assets, Current 3,437 5,080 2, Total Current Assets 44, , , , , , , , , , , , , , , , , , ,101 Marketable Securities - Long Term Capitalized Software Development, Net of Accumulated Amortization4,333 7,940 9,732 11,077 11,783 12,014 12,303 12,706 12,706 13,456 14,956 16,456 17,956 17,956 19,706 21,456 23,206 24,956 24,956 Property and Equipment, net 3,825 6,087 7,820 9,038 9,189 9,468 9,007 9,442 9,442 10,823 10,633 9,462 8,148 8,148 4,121 3,000 2,129 1,189 1,189 Goodwill 23,991 23,104 29,299 35,746 42,749 43,233 42,654 41,914 41,914 88,766 88,766 88,766 88,766 88,766 88,766 88,766 88,766 88,766 88,766 Intangible Assets 2,844 1,957 8,805 8,870 15,992 15,342 15,450 14,795 14,795 56, Deferred Tax Assets, Non-urrent 5, Other Assets ,794 3,794 5,068 5,068 5,068 5,068 5,068 5,068 5,068 5,068 5,068 5,068 Total Assets 84, , , , , , , , , , , , , , , , , , ,080 Liabilities and Equity Accounts Payable 8,002 9,689 11,886 18,044 22,241 23,451 21,134 23,543 23,543 21,773 22,333 23,979 24,783 24,783 25,340 25,982 26,469 27,014 27,014 Deferred Revenue 16,740 22,759 23,146 38,168 47,478 51,595 53,303 53,716 53,716 66,531 57,072 61,279 63,885 63,885 67,574 66,399 67,644 69,637 69,637 Capital Lease Obligations Total Current Liabilities 24,746 32,448 35,032 56,212 69,719 75,046 74,437 77,259 77,259 88,304 79,405 85,257 88,668 88,668 92,914 92,381 94,113 96,652 96,652 Long term debt 28,000 Deferred Tax Liabilities, non-current 6,173 6,173 5,437 5,838 5,838 5,547 5,547 5,547 5,547 5,547 5,547 5,547 5,547 5,547 5,547 Other long term liabilities ,649 2,649 3,855 3,855 3,855 3,855 3,855 3,855 3,855 3,855 3,855 3,855 Deferred revenue, non-current 2,408 1,507 3,657 3,657 2,691 2,691 2,691 2,691 2,691 2,691 2,691 2,691 2,691 2,691 Long-term debt and capital lease obligations Total liabilities 25,220 33,322 42,332 63,161 76,642 84,242 82,091 89,403 89, ,397 91,498 97, , , , , , , ,745 Total stockholders' equity 59, , , , , , , , , , , , , , , , , , ,335 Total Liabilities and Equity 84, , , , , , , , , , , , , , , , , , ,080 Scott Berg, Source: Company Reports and Needham & Co. Estimates $ in thousands, except per share data Needham & Company, LLC Page 35 of 75

36 Figure 26 HealthStream Statement of Cash Flows Cash Flow Statement Q 2Q 3Q 4Q Q 2QE 3QE 4QE 2015E 1QE 2QE 3QE 4QE 2016E Operating activities Net income (loss) 2,856 13,974 4,184 6,945 7,645 8,418 1,948 2,363 3,436 2,647 10,394 2, ,382 1,661 6,231 2,073 2,572 3,002 3,271 10,918 Total Depreciation and amortization 4,822 5,139 4,880 5,413 6,660 7,852 2,401 2,722 2,815 2,993 10,931 3,253 4,471 4,615 4,651 16,989 4,671 4,421 4,490 4,587 18,169 Amortization of acquired intangibles ,152 1, , ,800 1,800 1,800 6,150 1,800 1,800 1,800 1,800 7,200 Depreciation - 3,933 4,526 5,508 6,286 1,901 2,072 2,165 2,343 8,481 2,503 2,671 2,815 2,851 10,839 2,871 2,621 2,690 2,787 10,969 Deferred Income Taxes (375) (9,092) 2,674 4,048 5,601 2,506 1,395 1,770 1,354 (3,195) 1,324-1,300 1,300 1,300 3,900-1,300 1,300 1,300 3,900 Stock Based Compensation ,136 1, , , ,600 Loss on Equity Investments Excess Tax Benefit from Equity Awards (21) (111) (3,722) (3,363) (3,234) Provision for Doubtful Accounts Realized Loss On Disposal of PP&E Changes in Assets and Liabilities: Accounts and Unbilled Recievables (383) (1,393) (1,232) (4,997) 1,227 (10,056) (5,107) 1,549 1,667 (4,799) (6,690) 1,049 4,774 (3,976) (3,418) (1,572) 1,049 10,335 (2,468) (3,225) 5,691 Restricted Cash (4) (49) (19) Interest Receivable 13 (50) Prepaid and Other Assets (375) 50 (106) (251) (159) (6,220) (2,500) (1,993) 337 (3,801) (7,957) (1,944) 3,478 (1,463) (715) (644) (1,944) (571) (433) (485) (3,432) Prepaid Royalties (678) (1,089) (1,061) Prepaid Development Fees (89) (196) (395) Accounts Payable, accrued and other liabilities (429) , ,475 1,623 (414) (4,246) 11,733 8,696 (3,598) 560 1, (588) (3,598) (1,924) Accrued Liabilities and Accrued Compensation (1,211) 1,081 1, Commercial Support Liabilities 82 4 (274) Other Long-term Liabilities Deferred Revenue 709 2,032 4,507 6,018 (198) 14,761 8,599 6, ,553 17,471 6,881 (9,459) 4,206 2,606 4,235 6,881 (1,175) 1,245 1,993 8,944 Other Assets , , Net Cash provided by (used in) operating activities 1,221 7,379 16,149 19,757 22,513 26,283 9,189 12,913 6,573 5,581 34,256 9,007 5,989 8,110 7,290 30,393 9,767 17,924 8,023 8,387 44,098 CFO as a % of revs 2.4% 12.9% 24.6% 24.1% 21.7% 19.9% 24.0% 30.4% 14.8% 12.3% 20.1% 19.1% 12.1% 15.2% 13.2% 14.8% 17.3% 31.0% 13.6% 14.0% 18.9% Investing Activities Business combinations, net of cash acquired (9) (9,901) (7,560) (12,501) (12,298) (88,075) (88,075) Change in Marketable Securities - - (5,709) (6,928) (40,101) 1,584 5,341 (8,289) (958) 12,190 8,284 9, , Changes in Other Investments (234) (300) (250) (15) (60) (1,000) (1,325) (1,000) (1,000) Purchases of property and equipment (1,139) (1,787) (2,624) (4,115) (4,316) (4,444) (1,104) (1,319) (621) (1,500) (4,544) (2,313) (1,500) (1,500) (1,500) (6,813) (1,750) (1,750) (1,750) (1,750) (7,000) Payments associated with capitalized software development (980) (1,282) (2,044) (6,065) (4,435) (4,267) (1,464) (1,225) (1,336) (1,633) (5,658) (2,023) (1,500) (1,500) (1,500) (6,523) (1,750) (1,750) (1,750) (1,750) (7,000) Net cash provided by (used in) investing activities (2,128) (3,069) (10,377) (17,108) (58,987) (14,987) (9,978) (10,848) (2,772) 8,057 (15,541) (84,253) (3,000) (3,000) (3,000) (93,253) (3,500) (3,500) (3,500) (3,500) (14,000) Free Cash Flow (FCF) 82 5,592 13,525 15,642 18,197 21,839 8,085 11,594 5,952 4,081 29,712 6,694 4,489 6,610 5,790 23,580 8,017 16,174 6,273 6,637 37,098 Unlevered FCF (898) 4,310 11,481 9,577 13,762 17,572 6,621 10,369 4,616 2,448 24,054 4,671 2,989 5,110 4,290 17,057 6,267 14,424 4,523 4,887 30,098 ufcf as a % of revs -1.7% 7.5% 17.5% 11.7% 13.3% 13.3% 17.3% 24.4% 10.4% 5.4% 14.1% 9.9% 6.0% 9.6% 7.8% 8.3% 11.1% 25.0% 7.7% 8.1% 12.9% Financing Activities Proceeds from issuance of common stock 55,131 Issuance of Common Stock to Employee Stock Purchase Plan ,000 Proceeds from exercise of stock options , , , Excess Tax Benefits from Equity Awards , (129) 3,363 3, Repurchase of Common Stock (2,919) - (379) Payments of Long-term debt (724) (307) Payments on Capital Leases (123) (20) (9) (5) Payments on Promissory Note (707) Payment of earnouts related to acquistions (270) (154) (424) (19) Taxes paid related to net settlement of equity awards (164) (152) - (8) (1) (161) (213) (213) Net cash provided by (used in) financing activities (3,407) (319) (159) 56, , ,430 3,743 28, Net Increase (decrease) in cash and cash equivalents (4,314) 3,991 5,613 59,038 (35,540) 18,172 (492) 2,078 3,804 17,068 22,458 (47,231) 2,989 5,110 4,290 (62,826) 6,267 14,424 4,523 4,887 30,098 Cash and equivalents at beginning of period 3,599 (715) 12,287 17,868 76,904 41,365 59,537 59,045 61,123 64,927 59,537 81,995 34,764 37,753 42,863 81,995 47,153 53,420 67,844 72,367 19,169 Cash and equivalents at end of period (715) 3,276 17,900 76,904 41,365 59,537 59,045 61,123 64,927 81,995 81,995 34,764 37,753 42,863 47,153 19,169 53,420 67,844 72,367 77,254 49,267 Scott Berg, Source: Company Reports and Needham & Co. Estimates $ in thousands, except per share data Needham & Company, LLC Page 36 of 75

37 Paylocity (PCTY) Demand Trends Have Velocity; Raise PT to $40 Investment Thesis We are initiating coverage on Paylocity with a Buy rating and a $40 price target (raised from $32, last note published 2/6/15). We believe Paylocity is well positioned in the fast growing Software-as-a-Service Human Capital Management software market with a suite based on its Cloud core HRMS and payroll products purpose-built for the underserved mid-market. We believe demand for the functionality and flexibility of the SaaS delivery model for core HRMS products continues to increase, and we expect PCTY to broaden its product suite to serve this expanding demand. As a result, we believe PCTY can sustain subscription revenue growth above 20% annually for several years. Investment positives Demand in the SaaS core HRMS and payroll space is accelerating. Although the core HRMS market is a large and mature $20B market opportunity today, our research has shown that demand for SaaS delivery models has materially accelerated over the past three years, driving SaaS core HRMS and payroll annual growth of 15-20% and taking share from both on-premise vendors and service bureaus. We believe the majority of new core HRMS and payroll selections will continue to be for SaaS platforms, and we expect Paylocity to benefit from this evolving trend. ARPU increasing, driving increased profitability. While the company has increased its customer units roughly 25% annually for each of the last three fiscal years, average recurring revenue per user has increased 26% over the last two years, from roughly $10,300 to $13,100. We believe the driver of this growth to be a combination of both acquiring larger customers and also selling more product. Although we do not expect the company can maintain this 12% annual ARPU growth rate, we believe any sustained ARPU growth over 5% would drive additional profitability in the company s revenue model. Unique indirect distribution delivers large number of no-cost customer leads. Paylocity leverages a unique network of referral partners to deliver new customer leads at no cost. These partners delivered 25% of the company s new customers in FY14, roughly 450, but does not compensate these partners for the leads. As a result, we believe Paylocity has a lower CAC than other core HRMS vendors, which ultimately drives a more profitable model with S&M expense at less than 40% of total revenues. Highest percent of subscription revenues in the SaaS universe should drive higher relative valuation. Paylocity s recurring revenues currently comprise 92.3% of total FY14 revenue and is the highest percentage of recurring revenue to total revenues in our SaaS software universe. While this dynamic is partially a result of the company charging less to implement these customers, the mix of the high margin subscription revenues at normalized 20% services gross margins would be roughly 85% and still one of the highest ratios in our universe. We believe the markets will ultimately reward this ratio with a relatively higher valuation than most of the SaaS space, which has a lower mix given the value of these SaaS companies is entirely in high-margin subscription software. We prefer subscription-based revenue models given better visibility. We prefer the SaaS delivery model in general to on-premise, perpetual-license software delivery models because the SaaS model delivers more predictable near-term revenue and cash flows while also being more profitable over the long term. We believe this Page 37 of 75

38 model, when combined with the company s high renewal rates, gives investors a higher level of visibility into the company s near-term financials versus a perpetual license model. SaaS model offers better ability to innovate, staying ahead of legacy perpetual license vendors. We believe Paylocity is a prime example of how the SaaS model enables vendors to innovate new products significantly more quickly than perpetual license competitors can. Paylocity launched its HCM product in three short years from conception and today deploys new enhancements significantly faster than license competitors. While this difference is well known to SaaS investors, this distinction is particularly notable for Paylocity given that virtually all of its primary competitors have license-based architectures. We believe this architecture flexibility will enable Paylocity to develop a more innovative platform over the long term. Investment Concerns Lack of greenfield demand could limit growth opportunities as displacement sales can be more difficult. Penetration rates for HRMS and payrolls services are essentially 100%, implying new customer acquisitions can be made only through the displacement of an incumbent vendor. While Paylocity has found success replacing legacy vendors with its purpose-built, modern application suite, the number of deal opportunities is usually more limited in a fully penetrated market, which could limit near-term growth opportunities. Displacement sales also tend to be more difficult than greenfield sales as customers can be unwilling to change software vendors if the existing solution is at least adequate. Human Capital Management market is highly competitive. The HCM industry is extremely fragmented and highly competitive at all customer segment levels. While we believe Paylocity s integrated suite of HCM applications offers a unique and highly demanded value proposition, the company does compete against many larger and better capitalized competitors that could exert pricing pressure. We expect this market to remain highly competitive over the near term, requiring Paylocity to maintain innovative product development and competitive pricing. HRMS demand is sensitive to economic cycles. Our research has shown HRMS replacement and upgrade budgets have historically been highly sensitive to economic cycles. While we believe much of the industry's cyclical sensitivity is tied to premisebased software, we would expect the company's products to experience negative sales pressure in future economic downturns. Disruption of hosting services could negatively impact customer retention rates. Given that Paylocity delivers its software via a SaaS delivery model, any repetitive or long lasting service interruptions could adversely affect the company's ability to retain existing customers or attract new customers. We note, however, that we are not aware of any historical issues affecting Paylocity s software services. Valuation We derive our $40 price target for Paylocity using an EV/Revenue valuation methodology as we believe this allows for consistent comparison across Software-asa-Service (SaaS) companies. SaaS companies like Paylocity have historically traded at 2-10x forward-year Revenue multiples, and we believe Paylocity with its more profitable operating model and higher-than-average revenue growth rate should be trading at a premium to this range given our expected growth rate at its relative size. At 10x our FY16 revenue estimate of $191MM, we arrive at an Enterprise Value of $1.9B. After adding in $93MM in net cash, we believe the company should have a market value of $2.0B, or $40 per share. Page 38 of 75

39 Company Overview Paylocity, founded in 1997 by current Executive Chairman Steven Sarowitz, is a cloud-based provider of payroll and human capital management, or HCM, software solutions for medium-sized organizations between 20 and 1,000 employees. As of June 30, 2014, the company serves approximately 6,850 clients across the U.S., which on average had over 100 employees. Paylocity solutions help drive strategic human capital decision-making and improve employee engagement by enhancing the human resource, payroll and finance capabilities of their clients. Paylocity is headquartered in Arlington Heights, Illinois, employing roughly 968 people as of June 30, Paylocity has raised $140MM in proceeds through two public financing rounds. Through its IPO, the company sold 7.045MM shares at $17.00 per share in March The company sold 750k shares at $26.25 in a December 2014 follow-on offering. Paylocity markets and sells their products primarily through a direct sales force, generating sales leads through a variety of focused marketing initiatives and by referrals from an extensive network of 401(k) advisors, benefits administrators, insurance brokers, third-party administrators and HR consultants. Revenue is derived from a client based on the solutions purchased by the client, the number of client employees and the amount, type and timing of services provided with respect to those client employees. Paylocity has completed one acquisition to date with the purchase of BFKMS Inc. in May of 2014 for $9.4MM in cash. Given the company s current product roadmap, we do not foresee any additional near-term acquisitions but believe the company will likely be more acquisitory in the long term. Paylocity Products Paylocity s application suite currently focuses on two core Human Capital Management functional areas Human Resource Management and Payroll Management focusing on the medium-sized customer segment. The company s suite has been organically developed to deliver an employee system of record on a native Software-as-a-Service platform, purpose-built for the medium-sized organization. In addition to HCM and Payroll, Paylocity is investing to expand its product offering, recently introducing onboarding functionality and benefits administration. The company has extended its suite through partnerships with bswift (private) for its benefits solution for larger customers and with ATS OnDemand for its recruiting software solution. Page 39 of 75

40 Figure 27 Paylocity Product Suite Source: Company reports We believe what differentiates Paylocity is its product platform, its segment focus, and its sales distribution. Its platform is developed with broader functionality and an easy-to-use, Web 2.0 interface and is purpose-built with what we believe is the right amount of functionality for its mid-market customer target. The company also derives roughly 25% of its customers through a referral network yet pays no referral fee for the leads, resulting in a relatively low customer acquisition cost (CAC). Paylocity s suite is priced at roughly $200 per employee per year for all modules. Product Sales model: The company leverages a direct sales model, leveraging integration with an extensive ecosystem of referral partners to target specific geographic areas. Direct sales reps have responsibilities for driving their own sales along with engaging referral partners in their territories. Referral partners delivered 25% of the company s new customers in FY14. Technology: Paylocity utilizes a modern architecture including a Web Services framework with the Microsoft.NET technology stack. Mobile Strategy: We believe the company s mobile strategy to be a competitive advantage over other HRMS and payroll providers to medium sized businesses. The company offers extensive mobile functionality specifically designed for both individual employee functionality as well as management oversight. While the company leverages HTML5 in the core product, it also develops a native app for the Android and ios platforms. Paylocity People Steven Sarowitz - Executive Chairman Mr. Sarowitz founded Paylocity Corporation (Ameripay Corporation) in 1997 and served as its Chief Executive Officer and President. Mr. Sarowitz has guided Paylocity from a start-up operation to become a leader in the payroll service industry. He began his career in the payroll industry in 1989 at Robert F. White. He managed sales at two privately-held payroll companies prior to founding Paylocity. He also served as the President of the Independent Payroll Providers Association (IPPA). He serves as Page 40 of 75

41 Executive Chairman of Paylocity Holding Corporation. He holds a BA in Economics from the University of Illinois at Urbana. Steven Beauchamp - Chief Executive Office and President Mr. Beauchamp serves as the Chief Executive Officer and President at Paylocity Holding Corporation. Mr. Beauchamp has been the President and Chief Operating Officer of Paylocity Corporation since September 2007 and serves as its Chief Executive Officer. Previously, he was employed by Paychex, Inc., from September 2002 to August 2007 and served as Vice President of Product Management and as a Corporate Officer. He joined Paylocity in September 2007 and served as its Corporate Officer. Mr. Beauchamp served as Director of Product Management for Paychex in 2003 following Paychex's acquisition of Advantage Payroll Services, Inc. in September He served as a Vice President of Payroll Operations for Advantage Payroll Services, from August 2001 to September He served as President of Payroll Central, Inc., from May 1999 to August Mr. Beauchamp holds a Master's of Business Administration from Queen's University in Kingston, Ontario, Canada and a Bachelor's degree in Business Administration from Wilfrid Laurier University in Waterloo, Ontario, Canada. Peter McGrail - Chief Financial Officer Mr. McGrail serves as Chief Financial Officer and Principal Accounting Officer at Paylocity Holding Corporation. Mr. McGrail has been Chief Financial Officer of Paylocity Corporation since Mr. McGrail served as the Chief Financial Officer at Black Point Group. Prior to joining Black Point Group, he served as the Vice President and Chief Financial Officer of Advantage Payroll Services, Inc. since May Prior to joining Advantage, Mr. McGrail worked as a Consultant from January 1999 to April 1999 for Gordon Brothers. From January 1995 to December 1998, he served as the Vice President and Chief Financial Officer at Kitchen Etc. Prior to January 1995, he was the Controller at Nature Food Centers. He also spent seven years in public accounting with KPMG LLP. Mr. McGrail is a C.P.A. He received a Masters in Accounting degree from Bentley College and a B.A. degree in Economics from Colgate University. Financials We have modeled our Paylocity estimates based on several assumptions. These include: Paylocity recognizes subscription revenues ratably over the term of its contracts. We are modeling the company to invest in S&M and R&D more heavily post- IPO as it uses the newly raised capital to broaden its platform and distribution. We are modeling Subscription gross margin expansion in FY15 and FY16 as the company gains efficiency from the acquisition of company resellers. We do not expect the company to pay significant cash taxes for several years. Customer count growth and ARPU growth driving subscription revenue growth We note that Paylocity s 40% recurring revenue growth CAGR from FY12 to FY14 is a function of growth in both customer count and ARPU. Paylocity s customer count has grown at a CAGR of 25% during this time period while ARPU, which we calculate as total year subscription revenue divided by average customer count, has increased at an 8% CAGR during this period. We believe the company can sustain an ARPU growth rate of 5% as it sells more products and to marginally larger customers, but we expect customer additions to be the primary driver of subscription revenue growth. Page 41 of 75

42 Figure 28 PCTY Customer Count Figure 29 PCTY Average Recurring Revenue (ARPU) Total Customers 8500 CAGR: 24.5% Avg Recurring Revenue/Customer 14, CAGR: 8.1% 12, , , , , , Source: Company data, Needham and Company LLC Source: Company data, Needham and Company LLC Income Statement Overview We expect PCTY to generate FY15 total revenues of $150.7MM, a 38.7% Y/Y increase. We expect revenues associated with the company s Recurring Revenues to increase % Y/Y to $140.3MM and Implementation Services to increase 29.3% Y/Y to $8.7MM. We estimate blended gross margins will expand 430bp Y/Y to 54.8% based on higher recurring revenue margins versus FY13 levels due to a reseller acquisition. Our operating margin estimate of -0.8% for FY15m is a 20 bp Y/Y increase. We are modeling FY15 Non-GAAP EPS to be flat Y/Y at ($0.02). Figure 30 Paylocity Revenues vs. Operating Margins Source: Company data, Needham & Company, LLC estimates Cash Flows Paylocity is entering a new growth stage of its business following their IPO, currently operating at a cash inflow from operations. We estimate FY15 operating cash flow margins of 5.7%, with improvement for FY16 as the company better leverages margins as noted above. Paylocity should be a slightly capital-intensive business as they further expand their customer base and product offerings, requiring higher PP&E expense, implying unlevered FCF should lag CFO by roughly $ MM annually for the near future. Page 42 of 75

43 Figure 31 Paylocity Cash Flow Estimates E 2016E Operating cash flows $8,564 $6,228 $7,199 $8,593 $14,638 OCF margins 11.1% 5.7% 4.8% 5.7% 7.7% Free Cash Flow ($2,314) ($1,693) ($8,166) ($7,626) ($9,762) FCF margins -4.2% -2.2% -7.5% -5.1% -5.1% Source: Company reports and Needham & Company, LLC estimates Balance Sheet Paylocity has a relatively clean balance sheet with net cash of $93.2MM as of March 31, We note several items: DSOs: DSOs of two days are very low due to how the company invoices and collects. Paylocity invoices customers monthly and customer payments are remitted within a payroll cycle which results in the company collecting from the vast majority of customers in the month invoiced. A small number of customers are invoiced and make standard payments over a 30- to 60-day period. Intangible assets: The company has intangible assets and goodwill totaling $8.9MM as of March 31, 2015, for the first time in its history, caused by the recent acquisition of their reseller, BFKMS Inc. Funds held for clients: Funds held for clients are funds the company collects for employee payroll payments and related taxes in advance of remittance to employees and taxing authorities. Prior to remittance to employees and taxing authorities, Paylocity earns interest on these funds through financial institutions with which they have automated clearing house, or ACH, arrangements. This represents a large portion of current assets, and offers additional revenue upside potential should interest rates rise from the historically low rates experienced in recent years. Page 43 of 75

44 Figure 32 Paylocity Income Statement Income Statement Q14 2Q14 3Q14 4Q Q15 2Q15 3Q15 4Q15E 2015E 1Q16E 2Q16E 3Q16E 4Q16E 2016E Recurring revenues 36,443 51,211 71,309 20,738 22,145 30,719 26, ,362 29,142 32,055 43,335 35, ,257 38,176 41,672 55,035 45, ,896 Y/Y Growth 40.5% 39.2% 40.9% 39.1% 40.8% 42.0% 40.7% 40.5% 44.8% 41.1% 33.5% 39.8% 31.0% 30.0% 27.0% 26.0% 28.3% Q/Q Growth 10.0% 6.8% 38.7% -12.9% 8.9% 10.0% 35.2% -17.6% 6.9% 9.2% 32.1% -18.2% Interest income on funds held for clients 1,100 1,263 1, , , ,879 Y/Y Growth 14.8% 15.5% 16.9% 17.0% 9.8% -7.0% 8.4% 2.8% 3.2% 22.4% 5.0% 9.5% 5.0% 5.0% 15.0% 5.0% 8.5% Q/Q Growth -8.8% 7.1% 29.9% -26.7% 0.8% 7.4% 54.1% -37.1% 0.8% 7.4% 68.8% -42.6% Implementation services and other 1,941 2,622 4,526 1,278 1,382 2,556 1,527 6,743 1,604 1,868 3,336 1,909 8,717 1,989 2,298 4,103 2,348 10,738 Y/Y Growth 35.1% 72.6% 59.2% 44.1% 47.3% 48.4% 49.0% 25.5% 35.2% 30.5% 25.0% 29.3% 24.0% 23.0% 23.0% 23.0% 23.2% Q/Q Growth -71.8% 8.1% 84.9% -40.3% -76.2% 16.5% 78.6% -42.8% -77.2% 15.5% 78.6% -42.8% Total Revenue 39,484 55,096 77,294 22,369 23,905 33,766 28, ,687 31,109 34,313 47,272 38, ,705 40,546 44,379 59,830 47, ,634 Y/Y Growth 39.5% 40.3% 41.3% 39.0% 40.7% 41.4% 40.6% 39.1% 43.5% 40.0% 32.7% 38.7% 30.3% 29.3% 26.6% 25.6% 26.5% Q/Q Growth 10.4% 6.9% 41.3% -15.2% 8.6% 10.3% 37.8% -19.6% 6.7% 9.5% 34.8% -20.2% Cost of Revenue Recurring revenues 14,106 19,327 28,863 7,993 9,081 10,133 9,395 36,602 9,709 11,487 12,164 11,432 44,792 12,789 14,793 16,511 14,854 58,947 gross margins 61.3% 62.3% 59.5% 61.5% 59.0% 67.0% 64.9% 63.5% 66.7% 64.2% 71.9% 68.0% 68.1% 66.5% 64.5% 70.0% 67.0% 67.2% Implementation services and other 5,416 7,040 10,803 3,754 4,237 4,582 4,599 17,172 5,104 5,705 6,316 6,203 23,328 6,464 6,893 7,386 7,395 28,138 gross margins % % % % % -79.3% % % % % -89.3% % % % % -80.0% % % Total Cost of Revenue 19,522 26,367 39,666 11,747 13,318 14,715 13,994 53,774 14,813 17,192 18,480 17,635 68,120 19,253 21,686 23,897 22,250 87,086 Gross profit 19,962 28,729 37,628 10,622 10,587 19,051 14,653 54,913 16,296 17,121 28,792 20,376 82,585 21,293 22,692 35,933 25, ,548 Gross Margin 50.6% 52.1% 48.7% 47.5% 44.3% 56.4% 51.2% 50.5% 52.4% 49.9% 60.9% 53.6% 54.8% 52.5% 51.1% 60.1% 53.4% 54.3% Operating Expenses Sales and marketing 9,293 12,828 18,693 5,189 5,423 8,503 8,231 27,346 8,194 8,491 11,751 11,403 39,839 11,353 11,760 14,359 12,656 50,128 % of Revenue 23.5% 23.3% 24.2% 23.2% 22.7% 25.2% 28.7% 25.2% 26.3% 24.7% 24.9% 30.0% 26.4% 28.0% 26.5% 24.0% 26.5% 26.3% Research and development 1,565 1,788 6,825 1,956 2,347 2,304 2,778 9,385 3,302 4,231 4,107 4,371 16,011 4,460 4,660 4,786 5,015 18,921 % of Revenue 4.0% 3.2% 8.8% 8.7% 9.8% 6.8% 9.7% 8.6% 10.6% 12.3% 8.7% 11.5% 10.6% 11.0% 10.5% 8.0% 10.5% 9.9% General and administrative 6,868 8,618 11,556 3,730 5,060 4,746 5,685 19,221 6,223 6,760 7,354 7,602 27,939 7,298 7,988 8,376 8,596 32,259 % of Revenue 17.4% 15.6% 15.0% 16.7% 21.2% 14.1% 19.8% 17.7% 20.0% 19.7% 15.6% 20.0% 18.5% 18.0% 18.0% 14.0% 18.0% 16.9% Total Operating Expenses 17,726 23,234 37,074 10,875 12,830 15,553 16,694 55,952 17,719 19,482 23,212 23,377 83,790 23,111 24,408 27,522 26, ,308 Proforma Operating Income 2,236 5, (253) (2,243) 3,498 (2,041) (1,039) (1,423) (2,361) 5,580 (3,001) (1,205) (1,818) (1,716) 8,412 (759) 2,240 Proforma Operating Margin 5.7% 10.0% 0.7% -1.1% -9.4% 10.4% -7.1% -1.0% -4.6% -6.9% 11.8% -7.9% -0.8% -4.5% -3.9% 14.1% -1.6% 1.2% GAAP and Non-cash expenses 2,223 2, , , ,000 GAAP Operating income (434) (2,411) 2,133 (6,307) (7,019) (4,896) (6,466) 1,705 (6,986) (16,643) (5,918) (5,916) 4,112 (5,159) (14,760) Other income (expense) (179) (196) (16) Adjusted EBITDA 6,301 5,199 (275) 5, (246) 7,526 (1,049) 6, ,619 1,571 10,949 EBITDA Margins 0.0% 0.0% 8.2% 0.0% 0.0% 15.4% -1.0% 5.0% 1.3% -0.7% 15.9% -2.8% 4.4% 0.7% 0.8% 17.7% 3.3% 5.7% Proforma Income (loss) before income taxes 2,057 5, (225) (2,221) 3,557 (1,987) (876) (1,374) (2,281) 5,631 (2,951) (975) (1,768) (1,666) 8,462 (709) 2,440 Income tax (benefit) expense (36) 884 (399) (294) (809) 1, , ,950 Reported Tax Rate % -1.8% 16.7% -74.2% 130.7% 36.4% 44.3% -22.7% -29.1% -2.0% -1.5% 0.1% -5.1% -22.2% -8.5% -9.0% 17.7% -21.2% 79.9% Proforma Net Income (loss) 2,093 4, (1,412) 1,983 (2,439) (1,131) (1,402) (2,315) 5,627 (3,101) (1,191) (1,918) (1,816) 6,962 (859) 490 Net Margin 5.7% 8.6% 1.3% 0.3% -6.4% 6.5% -9.1% -1.1% -4.8% -7.2% 13.0% -8.7% -0.8% -5.0% -4.4% 12.6% -1.9% 0.3% GAAP Income (loss) before income taxes (166) 2, (406) (2,389) 2,192 (6,253) (6,856) (4,847) (6,386) 1,756 (6,936) (16,413) (5,868) (5,866) 4,162 (5,109) (14,560) Income tax (benefit) expense (36) 884 (602) (362) (877) 1, , ,450 Reported Tax Rate % 21.7% 34.4% % 89.2% 36.7% 47.5% -7.2% -3.7% -0.6% -0.5% 0.2% -2.2% -1.3% -2.6% -2.6% 24.0% -2.9% -10.0% GAAP Net Income (loss) (130) 1, (44) (1,512) 1,150 (6,705) (7,111) (4,875) (6,420) 1,752 (7,086) (16,629) (6,018) (6,016) 3,162 (5,259) (16,010) GAAP Net Margin -0.3% 3.1% 0.8% -0.2% -6.3% 3.4% -23.4% -6.5% -15.7% -18.7% 3.7% -18.6% -11.0% -14.8% -13.6% 5.3% -11.0% -8.4% Proforma EPS (0.04) 0.04 (0.05) (0.02) (0.03) (0.05) 0.11 (0.06) (0.02) (0.04) (0.03) 0.13 (0.02) 0.01 Y/Y Growth % 80.5% -70.9% % 158.1% -32.7% 439.1% % % 5.4% 143.9% 20.5% -4.6% 29.4% -25.6% 22.8% -72.5% % GAAP EPS (0.00) (0.00) (0.05) 0.03 (0.14) (0.16) (0.10) (0.13) 0.03 (0.14) (0.33) (0.12) (0.12) 0.06 (0.10) (0.31) Y/Y Growth % % -49.9% -89.1% 141.1% -59.0% % % % 172.9% 33.7% 3.5% 112.0% 20.6% -8.2% 79.0% -26.4% -5.2% Basic Shares Outstanding 37,539 43,873 31,988 31,988 31,988 44,360 49,564 45,436 49,566 49,775 50,533 50,633 50,127 50,733 50,833 50,933 51,033 50,883 Diluted Shares Outstanding 37,539 44,317 31,988 31,988 31,988 44,870 49,564 45,436 49,566 49,775 52,203 52,303 50,100 52,403 52,503 52,603 52,703 52,553 CFO 5,022 5,022 6, , ,199 (200) 1,049 9,352 Cash Balance 7,990 9,031 7,594 88,944 78,848 78,848 72,843 89,480 93,227 Cash/Share Scott Berg, Source: Company Reports and Needham & Company Estimates $ in thousands, except per share data Needham & Company, LLC Page 44 of 75

45 Figure 33 Paylocity Balance Sheet Balance Sheet Q 2Q 3Q 4Q Q 2Q 3Q 4QE QE 2QE 3QE 4QE 2016 Assets Cash and cash equivalents 7,990 9,031 7,594 88,944 78,848 78,848 72,843 89,480 93,227 88,219 88,219 85,025 82,152 92,339 85,656 85,656 Accounts receivable, net ,030 1, , Prepaid expenses & other ,875 3,160 2,694 2,694 3,072 2,978 4,844 3,611 3,611 3,852 4,216 5,684 4,537 4,537 Deferred income tax assets, net Total current assets before funds held for clients 9,829 10,831 10,811 93,458 83,004 83,004 77,420 94,172 99,825 93,464 93,464 90,372 87,940 99,903 91,833 91,833 Funds held for clients 298, , , , , , , , , , , , , , , ,616 Total current assets 308, , , , , , , , , , , , , , , ,449 Long-term prepaid expenses Capitalized software, net 2,725 3,714 2,614 3,800 5,093 5,093 5,574 5,704 6,206 7,131 7,131 8,421 9,712 10,973 12,203 12,203 Property and equipment, net 4,959 7,143 8,586 12,142 13,125 13,125 14,038 15,216 15,715 16,289 16,289 17,261 18,234 19,116 19,907 19,907 Intangible assets, net 6,320 6,320 6,130 5,940 5,750 5,550 5,550 5,350 5,150 4,950 4,750 4,750 Goodwill 3,035 3,035 3,035 3,035 3,035 3,035 3,035 3,035 3,035 3,035 3,035 3,035 Total Assets 316, , , , , , , , , , , , , , , ,556 Liabilities and Equity Current portion of long-term debt 312 1, Accounts payable 703 1, ,088 2,133 2,133 1,520 3,373 2,122 3,041 3,041 3,244 3,550 4,786 3,821 3,821 Taxes payable Consideration related to acquisition 2,985 2, Accrued expenses 4,326 5,265 6,794 10,572 10,744 10,744 10,777 11,720 15,985 13,304 13,304 14,191 15,533 20,940 16,715 16,715 Total current liabilities before client fund obligations5,341 8,045 8,506 13,660 15,867 15,867 12,907 15,512 18,107 16,345 16,345 17,435 19,083 25,727 20,536 20,536 Client fund obligations 298, , , , , , , , , , , , , , , ,616 Total current liabilities 304, , , , , , , , , , , , , , , ,152 Long-term accrued liabilities Long-term debt, not of current portion 3,188 1, Deferred rent 1,694 1,885 2,317 2,647 3,175 3,175 3,089 2,905 3,020 3,801 3,801 4,055 4,438 5,983 4,776 4,776 Deferred income tax liablities, net Total liabilities 309, , , , , , , , , , , , , , , ,679 Total convertible preferred stock 9,339 36,573 36,573 Common stock Additional paid-in capital 4, , , , , , , , , , , , ,557 Accumulated deficit (6,596) (27,678) (27,061) - (34,171) (34,171) (39,046) (45,466) (45,466) (45,466) (45,466) (45,466) (45,466) (45,466) (45,466) (45,466) Total stockholders' equity (2,254) (27,646) (26,592) 93,265 91,134 91,134 89, , , , , , , , , ,878 Total Liabilities & Shareholder Equity 316, , , , , , , , , , , , , , , ,556 Scott Berg, Source: Company Reports and Needham & Company Estimates $ in thousands, except per share data Needham & Company, LLC Page 45 of 75

46 Figure 34 Paylocity Statement of Cash Flows Statement of Cash Flows Q 2Q 3Q 4Q Q 2Q 3Q 4QE QE 2QE 3QE 4QE 2015 Operating Activities Net income (loss) (130) 1, (44) (1,512) 1,150 (6,704) (7,110) (4,875) (6,420) 1,752 (7,086) (16,629) (6,018) (6,016) 3,162 (5,259) (14,131) Stock-based compensation ,365 3,215 4,929 3,283 3,854 3,535 3,785 14,457 3,900 4,000 4,100 4,200 16,200 Depreciation and amortization 3,779 4,624 5,571 1,391 1,533 1,620 1,792 6,336 1,931 2,229 2,085 2,102 8,347 2,236 2,236 2,358 2,479 9,309 Depreciation 1,391 1,533 1,326 4,061 1,741 2,039 1,895 1,902 7,577 2,036 2,036 2,158 2,279 8,509 Amortization of acquired intangibles Amortization of capitaled SW costs 386 2, Deferred income tax (benefit) expense (42) 838 (822) (361) (878) 1, Provision for doubtful accounts (9) 73 (17) Loss on disposal of equipment Changes in operating assets and liabilities: - - (Increase) decrease in accounts receivable (339) 287 (295) (94) 144 (180) 52 (78) (85) (260) (58) 120 (283) 139 (77) (309) 241 (5) Increase in prepaid expenses (163) (247) (1,061) (695) (20) (914) 497 (1,132) (368) 175 (1,849) 1,233 (809) (241) (364) (1,468) 1,147 (926) Increase in trade accounts payable (482) 465 (245) 942 (338) 919 1, ,236 (966) 780 Increase in accrued expenses 1,416 1,009 1,497 (267) 562 2, , ,184 (2,681) 2, ,341 5,408 (4,225) 3,411 Net cash provided by operating activities 5,022 8,564 6, , ,199 (200) 1,049 9,352 (1,608) 8,593 1,106 1,427 14,486 (2,382) 14,638 Operating cash flow margins 9.11% 11.08% 5.73% 4.78% 5.70% 7.68% Investing Activities: Capitalized internally developed software costs (2,746) (3,716) (1,967) (1,024) (835) (1,060) (1,430) (4,349) (912) (667) (965) (1,400) (3,944) (1,800) (1,800) (1,800) (1,800) (7,200) Purchases of property and equipment (1,987) (3,446) (3,987) (1,412) (1,375) (2,167) (1,713) (6,667) (2,499) (1,666) (2,166) (2,000) (8,331) (2,500) (2,500) (2,500) (2,500) (10,000) Payments for acquisition (6,450) (6,450) (2,385) (200) (400) Net change in funds held for clients (176,480) 35,724 (92,650) 64,346 (200,204) (49,960) 124,462 (61,356) (14,964) (425,914) 126,523 - (314,355) Net cash used in investing activities (181,213) 28,562 (98,604) 61,910 (202,414) (53,187) 114,869 (78,822) (20,760) (428,447) 122,992 (3,400) (326,630) (4,300) (4,300) (4,300) (4,300) (17,200) Free Cash Flow 289 1, (2,138) (1,616) 3,958 (2,229) (3,817) (3,611) (1,284) 6,221 (5,008) (3,682) (3,194) (2,873) 10,186 (6,682) (2,562) Unlevered FCF (2,457) (2,314) (1,693) (3,162) (2,451) 2,898 (3,659) (8,166) (4,523) (1,951) 5,256 (6,408) (7,626) (4,994) (4,673) 8,386 (8,482) (9,762) ufcf margins -6.2% -4.2% -2.2% -14.1% -10.3% 8.6% -12.8% -7.5% -14.5% -5.7% 11.1% -16.9% -5.1% -12.3% -10.5% 14.0% -17.8% -5.1% Financing Activities Net change in client funds obligation 176,480 (35,724) 92,650 (64,346) 200,204 49,960 (124,462) 61,356 14, ,914 (126,523) Principal payments on long-term debt (467) (312) (1,625) (157) (156) (1,250) - (1,563) - - Proceeds from follow-on offering, net of issuance costs 18,716 (349) Payments on initial public offering costs (698) 82,032 (75) - - Proceeds from initial public offering, net of issuance costs 82,709 (677) 82,032 Capital contribution 1,052 1,052 Proceeds from issuance of long-term debt 519 Proceeds from issuance of Redeemable Convertible Preferred Series B Shares 27,234 Proceeds from exercise of stock options Proceeds from employee stock purchase plan 670 Taxes paid related to net share settlement of equity awards (1,380) (1,791) Payments on deferred offering costs Payments for redemption of Common Shares (27,371) (162) Net cash provided by financing activities 176,532 (36,085) 90,939 (64,503) 199, ,419 (124,087) 224,909 14, ,035 (128,597) Net Change in Cash and Cash Equivalents 341 1,041 (1,437) (2,295) (2,470) 85,417 (8,304) 153,286 (6,005) 16,637 3,747 (5,008) (318,037) (3,194) (2,873) 10,186 (6,682) (2,562) Cash and cash equivalents, beginning of peroid 7,649 7,990 9,031 7,594 5,299 7,594 78,848 72,843 89,480 93,227 78,848 (239,189) (242,383) (245,256) (235,069) (239,189) Cash and cash equivalents, end of period 7,990 9,031 7,594 5,299 2,829 78,848 72,843 89,480 93,227 88,219 (239,189) (242,383) (245,256) (235,069) (241,752) (241,752) Cash Flow Per Share Free Cash Per Share Scott Berg, Needham & Company, LLC Source: Company Reports and Needham & Company Estimates $ in thousands, except per share data Page 46 of 75

47 Ultimate Software (ULTI) The Ultimate Opportunity Remains; Upgrade to Buy, $195 PT Investment Thesis We are assuming coverage on ULTI with a Buy rating (upgrading from Hold, last note published 2/4/15) and $195 PT. Ultimate Software has been at the forefront of a marketplace accelerating toward customer use of Software-as-a-Service based Human Resource Management Systems (HRMS) versus legacy on-premise systems that we believe lack the innovation necessary to keep pace with today s changing workforce demographics. We believe ULTI with its industry-leading value proposition and broad product functionality will continue to capitalize on this stillyoung and burgeoning secular shift, and we believe it has a strong opportunity to grow its subscription billings greater than 20% annually for a multi-year period. We believe Ultimate s success thus far has been driven by a broad yet deep Human Capital Management product strategy with a platform having only four close competitors in Ceridian, Oracle, SAP, and Workday. Our prior research has shown that customers are accelerating their purchases of HCM suites, or multi-product combinations, from a single vendor versus a historical best-of-breed acquisition approach, which we believe will continue to disproportionally benefit Ultimate s future sales opportunities. We also believe customers prefer the functionality and flexibility of the SaaS delivery model for core HRMS over HRMS functionality delivered by the large service bureaus such as ADP and Ceridian. Today, over 50% of new Enterprise and almost two-thirds of new Workplace ULTI customers alone are coming from ADP, Ceridian, and Paychex. While we believe Ceridian is making improvements in new customer win rates and customer retention because of its acquisition of SaaS vendor Dayforce and subsequent product developed around it, we do not believe the other service bureau competitors are making enough competitive strides, which should result in additional drivers to push customers ULTI s way. Investment positives Large market opportunity allows for large growth opportunity. Ultimate competes in an $8-10B market opportunity today and is in a market that is accelerating technology adoption toward Ultimate's current Software-as-a-Service architecture. While Ultimate predominately competes only in North American markets today, the company's market penetration remains light counting roughly 10% of its Enterprise target market and 3% of its target SMB market as current customers. We believe this sizable market should yield significant growth opportunities for the company at multiples of its current revenue run-rate. One of the industry s broadest platforms yields competitive sales advantage. We believe Ultimate's platform is one of the industry's broadest, spanning core HRMS to many of the Talent Management functional areas. We believe this breadth gives Ultimate a material competitive sales advantage given customers' accelerating trend toward purchasing HR software in more suite combinations. We believe this competitive advantage is accentuated given the suite's industry-leading strength in SaaS-based core HRMS. We prefer subscription-based revenue models given better visibility. We prefer the SaaS delivery model in general to on-premise, perpetual license software delivery models because the SaaS model delivers more predictable near-term revenue and cash flows while also being more profitable over the long term. We believe this Page 47 of 75

48 model, when combined with the company s mid-90% renewal rates, gives investors a high level of visibility into the company s near-term financials. Spending on HCM software to remain at elevated levels in Our recent industry research suggests that spending for both core HRMS and Talent Management software will remain at elevated levels into While 2015 customer spending priorities are diverse, we note higher adoption of SaaS-based core HRMS and improved suite interoperability were most prominent in our recent discussions as customers seek more flexible platforms and fewer integration requirements. We believe Ultimate's current software suite should play well to both of these spending priorities. Investment Concerns Human Capital Management market is highly competitive. The Talent Management (TM) industry is extremely fragmented and highly competitive at all customer segment levels. While we believe Ultimate's integrated suite of TM applications offers a unique and highly in-demand value proposition, the company does compete against many larger and better capitalized competitors that could exert pricing pressure. We expect this market to remain highly competitive over the near term, requiring Ultimate to maintain innovative product development and competitive pricing. HRMS demand is sensitive to economic cycles. Our research has shown that HRMS replacement and upgrade budgets have historically been highly sensitive to economic cycles. While Ultimate executed well in 2009 during the Great Recession s growing total revenues 10% Y/Y and we believe much of the industry's cyclical sensitivity tied to premise-based software, we would expect the company's product to experience negative sales pressures in future economic downturns. Disruption of hosting services could negatively impact customer retention rates. Given Ultimate delivers its software via a SaaS delivery model, any repetitive or long-lasting service interruptions could adversely affect the company's ability to retain existing customers or attract new customers. We note, however, that we are not aware of any historical issues affecting Ultimate software services. Valuation We derive our $195 price target for Ultimate using an EV/Revenue valuation methodology as we believe this methodology allows for consistent comparison across Software-as-a-Service (SaaS) companies. SaaS companies like Ultimate have historically traded at 2-8x forward-year Revenue multiples, and we believe that Ultimate with its market-leading fundamentals should be trading at a premium to its current peer group, which has a median multiple of 4.0x FY16 revenue estimates. At 7.5x our FY16 revenue estimate of $740M, we arrive at an Enterprise Value of $5.6B. After adding in $128MM in net cash that the company currently has, we believe ULTI should have a market value of $5.7B, or $195 per share. Company Overview Ultimate is a leading provider of Human Capital Management software utilizing a modern Cloud, Software-as-a-Service delivery model. Founded in 1990 by Scott Scherr, Ultimate originally sold its software as an on-premise, perpetual license core HRMS product offering marketed to small and mid-sized customers. Ultimate is known today as one of the largest HCM SaaS vendors offering a complete solution across core HRMS and Talent Management functionality to customers in all segments. Ultimate is headquartered in Weston, FL, and had 2,354 employees as of December 31, Page 48 of 75

49 Ultimate has raised $30.2MM in net proceeds from a single public financing round, its 1998 Initial Public Offering. The company sold 3.25MM shares at $10 per share. Given that the company currently has $83MM in net cash, we do not foresee ULTI raising additional funds to finance operations; however, we note that we believe raising additional capital to fund acquisitions would be possible. Ultimate has completed two small acquisitions to date. The company acquired Hireworks, a recruiting software vendor, in 2003, and also acquired R.T.I.X., a Performance Management vendor, for $350k in We do not believe acquisitions are in the company s near-term plans. Figure 35 Ultimate Software Acquisition Date Company Price Functionality Gained Oct R.T.I.X Limited $3.6mm Performance Management Jun HireWorks $350k Recruiting Software Source: Company reports Ultimate s primary go-to-market sales strategy employs using separate, direct sales forces to market its two solutions suites, which target two different customer segments Enterprise for customers with greater than 1,000 employees and Workplace for fewer than 1,000 employees with less complex requirements. The company has 90 total quota-carrying sales representatives as of 1Q15, an increase from 30 in 2006, and expects to grow 10% plus annually over the next several years. Ultimate Products Ultimate has developed and sells a single HR software platform called UltiPro, delivered through a Software-as-a-Service (SaaS) subscription-based delivery model with an average contract duration of three years. UltiPro has several different functionality modules that enable customers to manage an employee s entire employment cycle from recruitment through employment termination. UltiPro is sold as two separate solutions, marketed as UltiPro Enterprise to customers with more than 1,000 employees and marketed as UltiPro Workplace for companies with fewer than 1,000 employees. Both the Enterprise and the Workplace editions have a very similar user interface, with the main differences being on functionality levels. UltiPro has historically been marketed almost exclusively to customers primarily based in the U.S. but began selling to Canadian-based companies in UltiPro is a multi-language global platform designed to support employees of these U.S and Canadian customers throughout the world. We note, however, that UltiPro's payroll administration is only available today for U.S.-based tax jurisdictions, thus requiring global customers to partner with third-party services to manage payroll capabilities outside of the U.S. The company has Canadian-based payroll functionality on its current product roadmap. Page 49 of 75

50 Figure 36 Ultimate Software Product Suite Source: Company reports Product Sales model: Since April 2009, the company has only sold its Software-as-a- Service product. However, the company continued to support customers on its legacy perpetual license product through the end of Although the majority of the company s customer base on the legacy platform migrated to the SaaS version, the sunsetting of support for the remaining customers created a roughly 2% growth headwind in 2015 with the elimination of associated maintenance revenues. Technology: The majority of Ultimate s software is developed using a Web 2.0, Web Services architecture utilizing Microsoft s C#.NET as its core programming language. Ultimate utilizes a multi-tenant architecture enabling Ultimate to leverage hardware requirements across multiple customers. However, the company is currently in the process of completely rewriting the platform that will leverage more open stack technologies. The company has already released its Recruiting and Onboarding solutions on the new platform. Mobile Strategy: Ultimate's current mobile strategy is based on a specific app developed for the ios platform. The current functionality allows limited HMRS functionality including enabling managers to process requests in their UltiPro inbox and enabling employees to sign in and out. We believe the new platform will add significant functionality to Mobile strategy once complete. UltiPro currently spans most functional space within HR software, with one notable exception in Learning Management. The current suite contains all the general functionality associated with a HRMS application including general employee information on employment and salary history, benefits, and payroll calculations. The suite s payroll functionality is limited to U.S. and Canadian based employees. The UltiPro suite also contains Talent Management functionality for Recruitment, Page 50 of 75

51 Onboarding, Performance Management, and Succession Management but has chosen to partner with third party Learning Management vendors to offer LMS functionality. While many software vendors will sell individual modules or software components independently depending on customer requirements, Ultimate requires customers to use the base UltiPro payroll functionality to purchase other modules in its suite. Management believes that dissatisfaction with core functionality and the fragmentation and integration issues with a multi-vendor approach (HRMS/Payroll) are principal reasons why companies change their HRMS/Payroll systems, and ULTI therefore believes that this strategy provides the best way to satisfy client needs and maintain industry-leading customer retention. The UltiPro Enterprise suite currently is list priced around $27 per employee per month domestically for all functionality. Ultimate People Scott Scherr, Chairman - President, and Chief Executive Officer Mr. Scherr founded The Ultimate Software Group, Ltd in 1990 and has served in his current capacity since Prior to founding the company, Mr. Scherr held senior management positions with ADP and Management Statistics. Mitchell Dauerman - Executive Vice President, Chief Financial Officer and Treasurer Mr. Dauerman joined the company as Chief Financial Officer and Treasurer in 1996 and has served in his current capacity since Prior to joining Ultimate, Mr. Dauerman held various positions with KPMG, serving as a partner in the firm for eight years. Mr. Dauerman is a Certified Public Accountant and earned a Bachelor of Arts in Economics from Rutgers University. Marc Scherr - Vice Chairman and Chief Operating Officer Mr. Scherr has been a Director since 1996 and became Vice Chairman in Mr. Scherr has served as Chief Operating Officer since Prior to joining Ultimate, Mr. Scherr served as a director of investment firm Gerschel & Co, Inc. as well as serving as an advisor to a real estate pension fund. Mr. Scherr was also previously a partner at the law firm of Fine & Ambrogne. Adam Rogers - Senior Vice President, Chief Technology Officer Mr. Rogers has served in his current position as Senior Vice president, Chief Technology Officer since Mr. Rogers joined Ultimate Software in 1997 and has held various research and development positions including Director of Technical Support, Director of Web Development, and Senior Vice President, Development, from Financials We have modeled our Ultimate estimates based on several assumptions. These include: Ultimate recognizes subscription revenues ratably over the term of its contracts. The company bills implementation professional services monthly, usually over a six-month term. The company bills subscription revenues for new contracts typically 60 days before a new contract's expected go-live date versus upon deal signing. These invoicing terms render the typical SaaS billings metric not useful for Ultimate. Page 51 of 75

52 The company has repurchased and will continue to repurchase outstanding stock for settling employees' tax withholdings. The company currently has 746k shares remaining under its current repurchase plan. Ultimate is unlikely to pay cash taxes until 2018 at the earliest. The company had $160MM in Federal net operating losses as of December 31, FY15 & FY16 overview We expect Ultimate to generate FY15 total revenues of $613.7MM, a 21.3% Y/Y increase, while essentially maintaining this growth rate through FY13 for $740.4MM in total revenues. We estimate FY15 recurring revenues of $514.2MM (22.% Y/Y increase) and FY16 recurring revenues of $627.3MM (22.0% growth). We are currently modeling gross margins to expand 90 bps Y/Y in FY15 to 62.6% predominately a result of revenue mix as subscription revenues grow faster than services. We estimate FY15 operating margins will expand 10 bps Y/Y to 20.2% with margin expansion limited because of the upfront investments in the company s new strategic segment. Our FY15 EPS estimate of $2.44 is a 16% Y/Y increase but we expect EPS growth to reaccelerate to 26% in FY16 to $3.06. Figure 37 Ultimate Software Total Revenues vs. Operating Margins % Revenue (mil) $627 $ $419 $334 $ $214 $107 $133 $ E 2016E Source: Company reports and Needham & Company, LLC estimates 35.0% 30.0% 25.0% 20.0% 15.0% 10.0% 5.0% 0.0% License revenue Services revenue Subscription revenue Operating Margin Recurring Revenue Ultimate's growth of recurring revenue as a percent of total revenues has jumped significantly with the company's decision to no longer sell its perpetual license software to new customers as of April 1, In 2007, recurring revenues comprised $87MM, or 57% of total revenues, and 56% of these recurring revenues came from the company's SaaS products. We estimate that recurring revenues will comprise 84% of total FY16 revenues, with 100% of these recurring revenues coming from the company's SaaS products with the decision to end the legacy on-premise product as of December 31, Page 52 of 75

53 Figure 38 Ultimate Software s Recurring Revenue Recurring revenues (mil) % 80% 81% 84% 84% 80% $627 75% % $ % 60% $ $ $266 $627 $214 $ $171 $396 $133 $107 $307 $ $236 $183 $139 $57 $74 $ E 2016E Source: Company reports and Needham & Company, LLC estimates 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% Maintainence revenues Legacy Ceridian Subscriptions SaaS revenues SaaS revenues as a % of total revenue Cash Flow Ultimate is not a capital-intensive business, requiring little working capital. We estimate the company will continue to improve its operating cash flow margins growing from low digits (11.8% in FY12) to roughly 9.5% in FY15. We estimate Ultimate will incur $44MM in FY15 CapEx and Capitalize Software development charges. We estimate this total CapEx charge should slow in FY16 as the company capitalizes less R&D after fully releasing its new platform. We estimate total FY16 CapEx to be $48MM for capitalized software and typical CapEx combined. Figure 39 Ultimate Software Cash Flow Estimates FY10 FY11 FY12 FY13 FY14 FY15E FY16E Operating Cash Flows (millions) $25,417 $28,411 $41,663 $74,212 $80,588 $102,205 $136,551 OCF margins 11.2% 10.6% 12.5% 18.1% 15.9% 16.7% 18.4% Unlevered FCF (millions) $20,437 $14,740 $24,337 $43,791 $42,488 $58,264 $88,551 ufcf margins 9.0% 5.5% 7.3% 10.7% 8.4% 9.5% 12.0% Source: Company reports and Needham & Company, LLC estimates Balance Sheet Ultimate has a relatively clean balance sheet with net cash of $123MM as of March 31, However, we note several items: DSOs: The company's DSO's have ranged from roughly 60 days to 70 days consistently over the past three years and were 63 days as of 1Q15. We are currently modeling DSO's to remain in this range throughout FY15. Funds held for clients: As part of the company's payroll business, Ultimate holds additional cash balances that are used to pay customer payroll tax liabilities. Current balance for Client funds is $847MM as of 1Q15. Goodwill: The company carries $3.0MM in Goodwill from its October 2006 acquisition of R.T.I.X. Deferred Revenues: The company's deferred revenues have increased 7.3% Y/Y to $111.4MM. Given the company's billings policies as noted above, we note that deferred revenue growth is not an appropriate proxy for current bookings. Page 53 of 75

54 Figure 40 Ultimate Software Income Statement Income Statement Q14 2Q14 3Q14 4Q Q15 2Q15E 3Q15E 4Q15E 2015E 1Q16E 2Q16E 3Q16E 4Q16E 2016E Recurring Revenue 87, , , , , , ,434 97, , , , , , , , , , , , , , ,342 Y/Y Growth 22.6% 25.1% 28.1% 25.1% 24.6% 25.5% 24.8% 26.4% 25.9% 24.3% 25.4% 22.0% 21.4% 23.0% 24.0% 22.7% 22.0% 22.0% 22.0% 22.0% 22.0% Q/Q Growth 7.8% 4.8% 5.1% 4.6% 5.8% 4.3% 6.5% 5.5% 4.1% 4.3% 6.5% 5.5% Service Revenue 49,857 60,627 59,043 55,368 53,195 64,563 75,110 23,208 19,841 20,047 23,069 86,165 25,768 22,024 24,056 27,452 99,300 29,118 24,666 27,665 31, ,019 Y/Y Growth 21.6% -2.6% -6.2% -3.9% 21.4% 16.3% 19.4% 21.0% 13.2% 6.9% 14.7% 11.0% 11.0% 20.0% 19.0% 15.2% 13.0% 12.0% 15.0% 15.0% 13.8% Q/Q Growth 7.6% -14.5% 1.0% 15.1% 11.7% -14.5% 9.2% 14.1% 6.1% -15.3% 12.2% 14.1% License Revenue 14,590 11,264 4,125 1,538 2,218 1, Y/Y Growth -22.8% -63.4% -62.7% 44.2% -42.5% -33.1% 15.9% -85.1% -86.3% % -37.5% -50.7% % % % -58.2% % #DIV/0! #DIV/0! #DIV/0! % Q/Q Growth % -89.4% -54.2% -50.0% % % #DIV/0! #DIV/0! #DIV/0! #DIV/0! #DIV/0! #DIV/0! Total Revenues 151, , , , , , , , , , , , , , , , , , , , , ,360 Y/Y Growth 17.9% 10.1% 15.9% 18.2% 23.4% 23.5% 23.7% 25.2% 23.6% 21.0% 23.3% 19.7% 19.7% 22.5% 23.1% 21.3% 20.2% 20.5% 20.9% 20.8% 20.6% Q/Q Growth 8.2% 0.8% 4.5% 6.3% 7.0% 0.8% 6.9% 6.8% 4.4% 1.0% 7.3% 6.8% Cost of Revenue Recurring 22,798 28,699 38,000 47,949 62,020 75,613 88,037 25,714 27,040 29,196 30, ,114 31,313 32,849 34,598 36, ,982 38,436 40,076 42,210 44, ,912 Gross Margins 73.8% 73.1% 71.5% 71.9% 71.0% 71.6% 73.7% 73.6% 73.5% 72.8% 73.2% 73.3% 73.7% 73.5% 73.8% 74.0% 73.7% 73.5% 73.5% 73.8% 74.0% 73.7% Service 40,327 48,118 47,030 48,605 50,877 63,334 72,986 21,019 19,904 20,406 20,164 81,493 23,036 22,244 24,297 24,707 94,284 26,206 24,913 27,942 28, ,473 Gross Margins 19.1% 20.6% 20.3% 12.2% 4.4% 1.9% 2.8% 9.4% -0.3% -1.8% 12.6% 5.4% 10.6% -1.0% -1.0% 10.0% 5.1% 10.0% -1.0% -1.0% 10.0% 4.9% License 1,659 1, Gross Margins 88.6% 84.2% 81.8% 83.4% 78.0% 78.0% 76.8% 84.1% 77.1% 77.3% 72.7% 82.9% 78.0% 78.0% 78.0% 78.0% 78.0% 78.0% 78.0% 78.0% 78.0% #DIV/0! Total Cost of Revenues 64,784 78,600 85,780 96, , , ,221 46,805 46,955 49,607 50, ,698 54,398 55,093 58,895 60, ,315 64,642 64,989 70,152 72, ,386 Gross Profit 86,680 99, , , , , ,176 74,273 75,042 77,824 85, ,238 90,479 90,890 97, , , , , , , ,975 Gross Margin 57.2% 56.0% 56.4% 57.5% 57.9% 58.1% 60.7% 61.3% 61.5% 61.1% 62.8% 61.7% 62.5% 62.3% 62.3% 63.5% 62.6% 62.9% 63.1% 62.8% 64.0% 63.2% Operating Expenses Sales & Marketing 36,479 39,804 45,751 51,695 56,321 64,704 80,254 24,032 24,525 23,089 24,620 96,266 32,980 30,656 29,661 33, ,651 36,573 34,300 35,867 40, ,046 % of Revneue 24.1% 22.3% 23.3% 22.7% 20.9% 19.5% 19.6% 19.8% 20.1% 18.1% 18.2% 19.0% 22.8% 21.0% 19.0% 20.0% 20.6% 21.0% 19.5% 19.0% 20.0% 19.9% Research & Development 28,162 35,168 37,247 41,004 49,731 58,242 64,172 18,450 19,255 20,221 20,828 78,754 20,150 21,167 23,417 25,015 89,749 25,950 26,736 28,316 30, ,232 % of Revneue 18.6% 19.7% 18.9% 18.0% 18.5% 17.5% 15.6% 15.2% 15.8% 15.9% 15.4% 15.6% 13.9% 14.5% 15.0% 15.0% 14.6% 14.9% 15.2% 15.0% 15.0% 15.0% General & Administrative 14,434 13,995 14,932 16,526 18,237 20,489 28,487 8,294 8,410 9,273 9,571 35,548 11,251 11,679 10,303 10,673 43,906 12,191 12,313 13,214 14,107 51,825 % of Revneue 9.5% 7.8% 7.6% 7.3% 6.8% 6.2% 6.9% 6.9% 6.9% 7.3% 7.1% 7.0% 7.8% 8.0% 6.6% 6.4% 7.2% 7.0% 7.0% 7.0% 7.0% 7.0% Total Operating Expense 79,075 88,967 97, , , , ,913 50,776 52,190 52,583 55, ,568 64,381 63,502 63,381 69, ,306 74,714 73,349 77,397 84, ,103 Proforma Operating Income (Loss) 7,605 11,005 12,869 21,777 31,524 49,606 76,263 23,497 22,852 25,241 30, ,670 26,098 27,387 33,835 36, ,117 34,803 37,559 41,224 44, ,871 Proforma Operating Margins 5.0% 6.2% 6.5% 9.6% 11.7% 14.9% 18.6% 19.4% 18.7% 19.8% 22.2% 20.1% 18.0% 18.8% 21.7% 22.1% 20.2% 20.0% 21.4% 21.8% 22.0% 21.3% GAAP & non-cash Expenses 10,380 15,641 13,455 13,530 15,092 20,412 33,049 11,127 11,464 11,636 13,100 47,327 16,341 16,500 17,000 17,500 67,077 18,000 18,500 19,000 19,500 75,000 GAAP Operating Income (2,775) (4,636) (586) 8,247 16,432 29,194 43,214 12,370 11,388 13,605 16,980 54,343 9,757 10,887 16,835 19,296 57,040 16,803 19,059 22,224 24,786 82,871 GAAP Operating Margin -1.8% -2.6% -0.3% 3.6% 6.1% 8.8% 10.5% 10.2% 9.3% 10.7% 12.5% 10.7% 6.7% 7.5% 10.8% 11.6% 9.3% 9.6% 10.8% 11.8% 12.3% 11.2% Total Other Income 5, (75) (310) (374) (125) 9 (10) (22) 9 (14) (58) (50) (50) (50) (208) (50) (50) (50) (50) (200) Adjusted EBITDA 14,465 20,926 24,454 33,379 43,061 63,229 92,079 27,450 27,279 30,157 34, ,794 31,080 36,086 42,651 45, ,889 44,084 47,085 50,973 54, ,378 EBITDA Margins 9.6% 11.7% 12.4% 14.7% 16.0% 19.0% 22.4% 22.7% 22.4% 23.7% 25.8% 23.7% 21.5% 24.7% 27.3% 27.5% 25.4% 25.3% 26.8% 27.0% 26.9% 26.5% Proforma Income Before Taxes 13,393 11,586 12,898 21,702 31,214 49,232 76,138 23,506 22,842 25,219 30, ,656 26,040 27,337 33,785 36, ,909 34,753 37,509 41,174 44, ,671 Income Tax 187 4,531 5,344 8,985 13,078 20,728 29,652 9,754 9,479 10,467 10,149 39,849 10,806 11,345 14,021 15,250 51,421 14,422 15,566 17,087 18,358 65,434 Tax Rate % 1.4% 39.1% 41.4% 41.4% 41.9% 42.1% 38.9% 41.5% 41.5% 41.5% 33.7% 39.2% 41.5% 41.5% 41.5% 41.5% 41.5% 41.5% 41.5% 41.5% 41.5% 41.5% Proforma Net Income (Loss) 13,206 7,055 7,554 12,778 18,136 28,504 46,486 13,752 13,363 14,752 19,940 61,807 15,234 15,992 19,764 21,497 72,487 20,330 21,943 24,087 25,878 92,238 Proforma Net Margin 8.7% 4.0% 3.8% 5.6% 6.7% 8.6% 11.3% 11.4% 11.0% 11.6% 14.7% 12.2% 10.5% 11.0% 12.7% 12.9% 11.8% 11.7% 12.5% 12.8% 12.8% 12.5% GAAP Pre-Tax Income 3,013 (4,055) (557) 8,172 16,122 28,820 43,089 12,379 11,378 13,583 16,989 54,329 9,699 10,837 16,785 19,246 56,832 16,753 19,009 22,174 24,736 82,671 Income Tax (19,736) (1,159) 585 5,161 11,840 14,188 17,559 5,496 5,015 (6,073) 5,154 9,592 5,539 4,497 6,966 7,987 24,989 6,952 7,889 9,202 10,265 34,309 Tax Rate % % 28.6% % 63.2% 73.4% 49.2% 40.8% 44.4% 44.1% -44.7% 30.3% 17.7% 57.1% 41.5% 41.5% 41.5% 44.0% 41.5% 41.5% 41.5% 41.5% 41.5% GAAP Net Income (Loss) 22,749 (2,896) (1,142) 2,158 4,282 14,632 25,530 6,883 6,363 19,656 11,835 44,737 4,160 6,340 9,819 11,259 31,842 9,800 11,120 12,972 14,470 48,363 GAAP Net Margin 15.0% -1.6% -0.6% 0.9% 1.6% 4.4% 6.2% 5.7% 5.2% 15.4% 8.7% 8.8% 2.9% 4.3% 6.3% 6.8% 5.2% 5.6% 6.3% 6.9% 7.2% 6.5% Proforma EPS Y/Y Growth % -45.8% 7.5% 63.6% 38.3% 54.0% 59.8% 46.4% 36.1% 25.0% 24.7% 31.4% 9.8% 17.9% 31.9% 6.2% 15.7% 31.7% 35.4% 20.3% 18.8% 25.6% GAAP EPS 0.85 (0.12) (0.05) Y/Y Growth % % -60.4% % 93.4% 234.9% 70.9% 49.1% 28.3% 209.8% 19.7% 73.2% -40.1% -1.9% -50.8% -6.3% -29.8% 132.4% 73.1% 30.4% 26.8% 49.9% Basic Shares Outstanding 24,701 24,588 24,463 24,960 25,814 26,778 27,772 28,196 28,252 28,285 28,432 28,291 28,583 28,883 29,183 29,483 29,033 27,477 27,777 28,077 28,377 27,927 Diluted Shares Outstanding 26,722 26,325 26,217 27,101 27,806 28,375 28,967 29,309 29,218 29,306 29,424 29,314 29,567 29,667 29,767 29,867 29,717 29,967 30,067 30,167 30,267 30,117 Deferred Revenue 43,262 54,687 60,980 71, , , , , ,282 Cash Flow-Operating 18,760 25,776 23,473 25,417 28,411 41,663 74,212 25,584 15,424 23,076 16,504 80,588 26,055 Cash Balance 53,418 23,005 33,207 50, ,688 91, , , ,924 Cash/Share Scott Berg, Needham & Company, LLC Source: Company Reports and Needham & Company Estimates $ in thousands, except per share data Page 54 of 75

55 Figure 41 Ultimate Software Balance Sheet Balance Sheet Q14 2Q14 3Q14 4Q Q15 2Q15E 3Q15E 4Q15E 2015E 1Q16E 2Q16E 3Q16E 4Q16E 2016E Assets: Cash & Cash Equivilents 23,684 40,889 46,149 58,817 79,794 91,080 80,967 99, , , , , , , , , , , , ,711 Investments in marketable securities 8,079 8,884 7,584 9,223 8,682 8,288 7,780 8,711 7,862 7,862 7,447 7,447 7,447 7,447 7,447 7,447 7,447 7,447 7,447 7,447 Accounts Receivable 38,450 47,570 56,186 70,774 85,676 82,256 84,354 88, , ,218 99,866 99, , , , , , , , ,134 Prepaid Exp. & Other current 15,594 18,613 22,944 25,949 29,374 31,578 32,528 34,729 34,788 34,788 36,666 37,955 42,150 43,359 43,359 43,540 45,733 50,969 52,399 52,399 Deferred tax assets 1,128 1,434 1,277 1,372 1, Funds held for clients 23,560 72, , , , , , , , , , , , , , , , , , ,172 Total Current Assets 110, , , , , , , ,255 1,011,218 1,011,218 1,107,408 1,131,565 1,169,326 1,204,528 1,204,528 1,241,827 1,271,874 1,321,529 1,363,846 1,363,846 PP&E 19,496 18,075 24,486 38,068 58,186 67,385 75,147 82,188 86,595 86,595 96,652 97, , , , , , , , ,618 Capitalized Software 4,463 3,115 1, ,056 25,056 25,056 25,056 25,056 25,056 25,056 25,056 25,056 25,056 Goodwill 3,198 3,025 3,025 3,025 26,942 25,813 26,169 25,774 25,696 25,696 2,651 2,651 2,651 2,651 2,651 2,651 2,651 2,651 2,651 2,651 L-T Investments in marketable securities 1, ,546 1,311 1,771 2,320 2,548 1,973 2,294 2,294 6,203 6,203 6,203 6,203 6,203 6,203 6,203 6,203 6,203 6,203 Deferred tax assets, net 8,274 7,822 7,704 7,218 6,774 6,774 Other L-T 12,298 11,656 15,056 16,687 17,340 17,593 18,603 19,284 20,611 20,611 22,779 23,357 23,417 25,015 25,015 26,124 24,626 25,484 27,207 27,207 L-T deferred tax assets 19,736 22,988 20,142 18,543 18,913 20,116 21,250 35,619 37,110 37,110 40,556 40,556 40,556 40,556 40,556 40,556 40,556 40,556 40,556 40,556 Total Assets 171, , , , ,194 1,066, , ,311 1,190,298 1,190,298 1,301,305 1,327,341 1,367,346 1,407,134 1,407,134 1,448,261 1,479,284 1,532,049 1,578,137 1,578,137 Liabilities: Accounts Payable 4,476 4,683 6,265 7,584 6,422 8,769 7,341 7,935 7,418 7,418 9,633 8,759 9,367 9,172 9,172 11,320 10,554 11,326 11,084 11,084 Accrued Expenses 9,972 11,074 11,589 15,055 26,040 27,196 26,647 32,374 30,941 30,941 34,645 32,116 39,028 38,356 38,356 41,798 38,697 47,193 46,353 46,353 Deferred Revenue 60,980 71,808 83,416 90, , , , , , , , , , , , , , , , ,104 Capital lease obligations 1,897 2,551 2,694 2,968 2,949 3,231 3,576 3,675 3,655 3,655 4,423 4,423 4,423 4,423 4,423 4,423 4,423 4,423 4,423 4,423 Current portion of L-T debt ,311 2,264 2, Client Fund obligations 23,560 72, , , , , , , , , , , , , , , , , , ,172 Total Current Liabilities 100, , , , , , , , , ,220 1,007,724 1,006,906 1,016,081 1,023,099 1,023,099 1,032,418 1,029,819 1,046,599 1,054,705 1,054,705 Deferred revenue 7,579 6,287 3,147 1, Deferred rent 3,186 3,022 3,384 2,777 2,687 2,495 2,724 2,281 2,368 2,368 2,609 2,609 2,609 2,609 2,609 2,609 2,609 2,609 2,609 2,609 Capital lease obligations 1,710 2,406 2,175 2,469 2,240 2,748 3,369 3,454 3,359 3,359 4,724 4,724 4,724 4,724 4,724 4,724 4,724 4,724 4,724 4,724 Income taxes payable - 1,866 1,866 2, L-T debt ,866 1,371 1,244 1,244 1,131 1,049 1, , ,049 1,049 1,049 1,049 1,049 1,049 1,049 Total Liabilities 113, , , , , , , , , ,549 1,016,399 1,015,834 1,024,781 1,032,048 1,032,048 1,041,374 1,038,777 1,055,570 1,063,688 1,063,688 Stockholser Equity: Total Stockholders Equity 57,770 72,985 85, , , , , , , , , , , , , , , , , ,449 Total Liabilities & Stockholders Equity 171, , , , ,194 1,066, , ,311 1,190,298 1,190,298 1,301,305 1,327,341 1,367,346 1,407,134 1,407,134 1,448,261 1,479,284 1,532,049 1,578,137 1,578,137 Scott Berg, Source: Company Reports and Needham & Company Estimates $ in thousands, except per share data Needham & Company, LLC Page 55 of 75

56 Figure 42 Ultimate Software Statement of Cash Flows Statement of Cash Flows Q14 2Q14 3Q14 4Q Q15 2Q15E 3Q15E 4Q15E 2015E 1Q16E 2Q16E 3Q16E 4Q16E 2016E Operating Activities Net Income 2,158 4,282 14,632 25,530 6,883 6,363 19,656 11,835 44,737 4,160 6,340 9,819 11,259 31,842 9,800 11,120 12,972 14,470 48,363 D & A 11,883 11,620 13,623 16,058 4,242 4,713 5,202 5,106 19,263 5,246 8,699 8,816 9,012 31,773 9,281 9,526 9,749 9,951 38,507 Depreciation 11,883 11,620 12,366 15,550 4,242 4,713 5,202 5,106 19,263 5,246 8,699 8,816 9,012 31,773 9,281 9,526 9,749 9,951 38,507 Amortization 1, Doubtful Accounts 1,549 1,586 1,159 2, , Tax Charge for equity awards Stock-based comp. 13,249 15,009 20,412 32,807 10,838 11,178 11,350 12,819 46,185 16,077 16,500 17,000 17,500 67,077 18,000 18,500 19,000 19,500 75,000 Loss on foreign currency Deferred income taxes 4,982 11,507 13,814 17,347 5,261 4,992 (6,285) 5,062 9,030 5,243 4,000 4,000 4,000 17,243 4,000 4,000 4,000 4,000 16,000 Excess tax benefits (6,671) (8,504) (12,310) (19,167) (6,558) (6,093) (8,157) (6,691) (27,499) (8,845) (8,000) (8,000) (8,000) (32,845) (9,000) (9,000) (9,000) (9,000) (36,000) Accounts Receivable (10,669) (10,202) (15,747) (16,784) 2,931 (2,705) (4,441) (12,591) (16,806) (621) 598 (8,449) (15,690) (24,162) 10,204 (6,406) (10,643) (18,882) (25,728) Prepaid expenses and other current assets (3,019) (4,331) (1,880) (2,982) (2,204) (950) (2,201) (59) (5,414) (1,878) (1,289) (4,195) (1,209) (8,571) (181) (2,193) (5,235) (1,430) (9,039) Other Assets 362 (3,483) (1,631) (403) (253) (1,010) (681) (1,327) (3,271) (2,168) (578) (60) (1,598) (4,404) (1,109) 1,498 (859) (1,723) (2,192) Accounts Payable 207 1,582 1,319 (1,415) 2,350 (1,431) 594 (517) 996 2,215 (874) 608 (195) 1,754 2,148 (767) 773 (242) 1,912 Accrued expenses and deferred rent ,859 10, (322) 5,284 (1,346) 4,582 3,945 (2,529) 6,912 (672) 7,656 3,442 (3,101) 8,496 (840) 7,996 Deferred revenue 9,536 8,468 5,413 9, ,104 3,696 6,521 1,708 2,599 1,666 7,895 13,869 3,736 1,270 7,525 9,200 21,732 Cash Flow From Operating Activities 25,417 28,411 41,663 74,212 25,584 15,424 23,076 16,504 80,588 26,055 25,465 28,118 22, ,205 50,322 24,447 36,776 25, ,551 Operating cash flow margins 11.2% 10.6% 12.5% 18.1% 21.1% 12.6% 18.1% 12.2% 15.9% 18.0% 17.4% 18.0% 13.4% 16.7% 28.9% 13.9% 19.5% 12.4% 18.4% Investing Activities Purchases of marketable securities (9,223) (14,610) (13,643) (10,741) (2,833) (3,252) (2,250) (2,020) (10,355) (1,765) (1,765) - Maturities of marketable securities 9,429 14,794 12,239 10,819 2,675 3,533 1,888 2,281 10,377 1,823 1,823 - Capitalized software Acquisition related expenses Payment of acquisitions, net of cash acquired (24,995) (257) (257) Net purchases of client fund securities (49,315) (45,785) (162,347) 20,908 (448,926) 249,252 83,062 (380,248) (496,860) (88,085) (88,085) - Purchases of P&E (4,980) (13,671) (17,326) (30,421) (11,205) (9,809) (10,241) (6,845) (38,100) (10,941) (10,000) (11,000) (12,000) (43,941) (12,000) (12,000) (12,000) (12,000) (48,000) Cash Flow From Investing Activities (54,089) (59,272) (181,077) (34,430) (460,289) 239,724 72,459 (387,089) (535,195) (98,968) (10,000) (11,000) (12,000) (131,968) (12,000) (12,000) (12,000) (12,000) (48,000) Free Cash Flow 20,437 14,740 24,337 43,791 14,379 5,615 12,835 9,659 42,488 15,114 15,465 17,118 10,303 58,264 38,322 12,447 24,776 13,005 88,551 FCF margins 9.0% 5.5% 7.3% 10.7% 11.9% 4.6% 10.1% 7.1% 8.4% 10.4% 10.6% 11.0% 6.2% 9.5% 22.0% 7.1% 13.1% 6.5% 12.0% Financing Activities Repurchases of C/S (19,784) (17,310) (9,794) (19,981) - - (19,981) (6,191) Net Proceeds from C/S 14,897 13,282 11,284 8,139 2, ,600 1,579 6,208 1,569 1,569 - Excess tax benefits 6,671 8,504 12,310 19,167 6,558 6,093 8,157 6,691 27,499 8,845 8,000 8,000 8,000 32,845 9,000 9,000 9,000 9,000 36,000 Shares acquired to settle tax withholding liability (2,797) (10,941) (20,384) (18,058) (10,216) (511) (1,454) (7,702) (19,883) (10,068) (10,068) - Principal payments on capital lease obligations (2,503) (3,016) (3,418) (3,541) (919) (1,011) (1,066) (1,086) (4,082) (1,184) (1,184) - Net increase in customer fund obligations 49,315 45, ,347 (20,908) 448,926 (249,252) (83,062) 380, ,860 88,085 88,085 - Repayments of borrowings on L-T debt - - (429) (2,055) (293) (1,766) (166) (465) (2,690) (98) (98) - Cash Flow From Financing Activities 45,799 36, ,916 (17,256) 446,351 (265,694) (75,991) 379, ,931 80,958 8,000 8,000 8, ,149 9,000 9,000 9,000 9,000 36,000 Effect of Foreign currency on cash 79 (183) 166 (1,549) (360) 433 (588) (305) (820) (1,069) (1,069) - - Net change in cash & cash equivalents 17,206 5,260 12,668 20,977 11,286 (10,113) 18,956 8,375 28,504 6,976 23,465 25,118 18,303 80,317 47,322 21,447 33,776 22, ,551 Beginning cash & cash equivalents 23,684 40,889 46,149 58,817 79,794 91,080 80,967 99,923 79, , , , , , , , , , ,615 Ending cash & cash equivalents 40,889 46,149 58,817 79,794 91,080 80,967 99, , , , , , , , , , , , ,166 Scott Berg, Source: Company Reports and Needham & Company Estimates $ in thousands, except per share data Needham & Company, LLC Page 56 of 75

57 Workday (WDAY) First SaaS Horizontal Platform Executing Well; Initiate with Buy, $107 PT Investment Thesis We are initiating coverage on WDAY with a Buy rating and $107PT. In general, we believe the company has the right combination that growth investors seek: large market, well positioned product versus industry megatrends, and a financial model yielding significant revenue visibility. We believe the presence of all of these factors are currently driving a high revenue growth rate at WDAY. Although we believe the company's current valuation assumes almost flawless near-term sales execution to further expand its valuation multiples, we believe its execution within a HCM market exhibiting high demand yields a positive risk/reward scenario for investors in the near term even though sales of the company s Financials platform remain limited. While most know Workday as the new HCM Software-as-a-Service offshoot of former PeopleSoft founder and CEO Dave Duffield, we believe the company is undertaking a more ambitious effort to redefine the Enterprise Application suite in the Cloud. Just 10 short years after its founding, we believe Workday is already highly competitive for Human Capital Management software sales focusing on HRMS to mid and large sized customers that are more frequently dominated by Oracle and SAP. However, what we believe makes Workday different from any other SaaS vendor today is the breadth of its horizontal platform. With a burgeoning platform that includes Financials, Payroll, Big Data Analytics and eventually a higher education platform, we believe Workday has grander plans to be the first SaaS end-to end ERP platform to truly integrate across all standard application functionalities for the enterprise in a single platform. We also believe customers' preferences are evolving toward the functionality and flexibility of the SaaS delivery model for ERP functionality rather than the ERP functionality delivered by historical broad ERP suites such as Epicor (private), Infor (private), Oracle, or SAP. We believe that, along with our independent research, the recent SaaS acquisitions over the past several years by Oracle and SAP and multi-year development efforts at companies like Epicor and Infor support this theory. However, we do not believe that most legacy on-premise ERP vendors will be able to catch up with Workday's SaaS functionality over the next several years. Investment positives Large market opportunity allows for large growth opportunity. Workday competes in a $40-50B market opportunity today and is in a market that is accelerating technology adoption toward Workday s current Software-as-a-Service architecture. With just over 700 total customers and $1.55B in estimated FY16 revenues, we believe this sizable market provides Workday with significant growth opportunities at multiples of its current revenue run-rate. Leading horizontal SaaS ERP play. We believe Workday has the broadest horizontal platform across SaaS Enterprise software companies. This platform allows the company multiple sales opportunities within a customer, giving Workday the most upsell potential of any current SaaS software vendor in our view. While we acknowledge this product strategy is a grand effort with many complexities for a young company and is not yet complete, we note that its success would likely catapult the company ahead of other leading SaaS vendors that currently have no existing plans to move beyond their respective current vertical specialization. Page 57 of 75

58 We prefer subscription-based revenue models given better visibility. We prefer the SaaS delivery model in general to on-premise, perpetual license software delivery models because the SaaS model delivers more predictable near-term revenue and cash flows while also being more profitable over the long term. We believe this model, when combined with the company s high renewal rates, gives investors a higher level of visibility into the company s near-term financials versus a perpetual license model. SaaS model offers better ability to innovate, staying ahead of legacy perpetual license vendors. We believe Workday is a prime example of how the SaaS model enables vendors to innovate new products significantly more quickly than perpetual license competitors. Workday launched its HCM product in three short years from conception and today deploys new enhancements significantly faster than license competitors. While this difference is well-known to SaaS investors, this distinction is particularly notable for Workday given that virtually all of its primary competitors have license-based architectures. We believe this architecture flexibility will enable Workday to develop a more innovative platform over the long term. Focus on large customer segment more profitable. We believe Workday s focus on the mid-size to large customer segments provides a more profitable long-term model. We believe these customer segments have lower customer acquisition costs when amortized over the life of an average customer than those vendors that focus on selling only to the SMB segment. Our research also shows that while the average per seat or per employee cost for a large customer is less than a small customer for most SaaS companies, the infrastructure and support costs are materially less for a large customer than the cumulative costs associated with multiple small customers that would equal a similar sized employee base. We believe the lower relative CAC and support costs for mid-sized to large customers drive a more profitable model over the long term. Investment Concerns Financials remain mostly untested. While we believe much of Workday s investment allure is the horizontal breadth of its SaaS platform, the company s Financials modules enjoy only very modest adoption to date. Our research has shown increasing customer interest in the company s Financial modules, but functionality depth lags more established competitors that are required to sell into the complex environments of the larger customers that Workday covets. Struggle between IT departments and HR over core HRMS and ERP systems is real, and impacts the SaaS versus on-premise decision. While the SaaS platform and architecture is essentially the de facto and preferred platform available for Talent Management applications, our research on ERP and core HRMS systems has shown that significant strife remains between IT departments and HR over the delivery methodology for both platforms. We make no mistake that SaaS-based core HRMS is clearly becoming the preferred platform for small and mid-market customers and is gaining significant momentum in the large enterprise, but the internal platform and architecture discord with large customers is noticeably impacting SaaS HRMS adoption rates and seems to have made SaaS ERP adoption among large enterprises almost non-existent. As a result, we believe SaaS HRMS and ERP adoption over the near term in the large enterprise could be slower than current expectations. Oracle and SAP discounting HRMS modules, could pressure near-term sales. Our recent industry checks have shown that Oracle (ORCL not rated) and more so SAP (SAP not rated) are deeply discounting or giving away HRMS licenses and maintenance costs to win or maintain core HRMS business from Workday in customers that currently use Oracle or SAP s ERP suites. We view this promotional response as unsustainable for several reasons but recognize that this marketing Page 58 of 75

59 approach is impacting customer purchasing decisions. We believe Workday is less able, and less willing, to compete on price today, but we believe the company does not need to compete solely on price given our expectation that the technological and functionality advantages that customers would gain from a SaaS platform long term would likely outweigh this near-term pricing pressure. Valuation to infinity, and beyond (in our opinion).we believe the largest investment concern on Workday is its current valuation at 13x FY16 revenues relative to its actual long-term sales opportunity. Its current valuation remains in uncharted territory. Even after the compression in SaaS multiples over the past year, Workday s stock continues to have a higher multiple than any SaaS company ever, Netsuite at roughly 13x forward revenues in CY12. However, we note that at the company s current revenue run rate, Workday is growing materially faster than any other public SaaS company has ever grown. Although Workday also targets the largest addressable market for any SaaS vendor today, we believe further multiple expansion will likely be extremely limited from current valuation levels. Two stock classes limit investor influence. Following recent trends, Workday has two common stock classes. While the rights are equal between the two classes, each share of Class B common shares is entitled to 10 votes versus a single vote for Class A common shares. This structure limits shareholder influence over company governing matters given Class B holders represent over 90% of current voting rights. Valuation We derive our $107 price target for Workday using an EV/Revenue valuation methodology as we believe this methodology allows for consistent comparison across Software-as-a-Service (SaaS) companies. SaaS companies like Workday have historically traded at 2-8x forward-year Revenue multiples, and we believe that Workday with its market-leading growth rates should be trading at a premium to its current peer group. At 15.0x our FY16 revenue estimate of $1.13B, we arrive at an Enterprise Value of $17.0B. After adding in $1.3B in net cash the company currently has, we believe the company should have a market value of $18.3B, or $107 per share. Company Overview Workday is a leading provider of cloud-based enterprise applications for Human Capital Management, financial management, payroll, analytics, and employee expense management. Founded in 2005 by Dave Duffield and Aneel Bhuri, Workday has expanded its suite annually from just HCM in 2006 to the industry s first horizontal Cloud platform. Workday markets its applications predominately to mid-size and enterprise level customers, those with greater than 1,000 employees, across all customer verticals. We believe its sales sweet spot is with customers that have 5k- 20k employees. Workday is headquartered in Pleasanton, CA, and has approximately 3,750 employees as of January 31, Workday has raised $1.55B in total equity proceeds to date and $600MM in convertible debt. The company raised $250MM through six private equity funding rounds while raising $685MM from its October 2012 IPO and an additional $614MM from a follow-on offering in January Given the company currently has $1.3B in net cash, we do not foresee WDAY raising additional funds to finance operations or acquisitions in the near term. Workday has completed two small acquisitions to date, acquiring Cape Clear in February 2008 and Identified in While financial details of the Cape Clear deal were never announced, we believe the acquisition price was slightly greater than $10MM given gross intangible assets and Goodwill were $9.4MM at the time of the company s IPO. We believe the Identified acquisition was roughly $26MM. Given the company s leading edge architecture, we would expect the company s near-term Page 59 of 75

60 acquisition strategy to resemble its historical strategy of acquiring technologies to augment its underlying architecture versus purchasing front-end applications to expand its application suite. We believe any front-end application acquired would require the company to completely rewrite it to leverage both its database technology and data structure. Figure 43 Workday Acquisition History Date Name Price Product description Feb-08 Cape Clear n/a Integration service that allows the exchange of information between applications. Feb-14 Identified $26.3mm An analytics platform with advanced search capabilities. Total: n/a Source: Company reports Source: Company data, Needham & Company, LLC Workday s primary go-to-market sales strategy utilizes a direct sales model. We believe most of the company s partner ecosystem to revolve around implementations but we believe that over the longer term, a higher portion of sales could come from indirect sales partners. Workday Products Workday s application suite currently focuses on two core functional areas Human Capital Management and Financial Management but is expanding beyond these two primary areas including Big Data and a back-office suite for higher education called Workday Student. All current applications have been organically developed on the company s native Software-as-a-Service platform, with the exception of its integration layer acquired in The Workday platform is a single code base that is sold to all target customer segments versus most vendors that market different solutions to different customer segments. Page 60 of 75

61 Figure 44 Workday Solutions Source: Company data, Needham & Company, LLC We believe that what differentiates Workday s platform versus other large enterprise application vendors is its combination of a native SaaS architecture and its wide breadth of fully unified solutions in this SaaS platform. We believe Workday is attempting to become the first horizontal SaaS platform versus a vertical focus approach taken by most SaaS vendors. We believe this modern architecture delivers significant performance improvements over existing legacy on-premise software because of how data is both accessed and processed. This improved application performance is the result of how the company s suite accesses data. First, Workday s suite utilizes an object-oriented architecture that combines business logic with data versus most legacy systems which separate the logic from the data. The flexibility of an object-oriented architecture also allows for more rapid product development cycles. Second, Workday utilizes memory data management, bringing data closer to the application and eliminating time-intensive disk-seek operations. While neither of these concepts is radically new, most competitor platforms are tied to older technology stacks and we expect will likely be stuck on these aging platforms for several years or longer. This tie to legacy technology on the part of most of WDAY s competitors will likely allow Workday to extend its competitive technological advantage over most large ERP suites over the next five years, in our opinion. Product Sales model: All Workday products are sold in a multi-tenant, Software-asa-Service environment using a direct sales force. Workday has developed an extensive partner eco-system but we believe most of these are more product implementers versus an indirect sales force. Customers typically cannot purchase modules individually. Customers typically must purchase the company s core HRMS product before purchasing other HCM modules. Technology: Workday s suite is developed using Web 2.0, Service-Oriented Architecture utilizing Java development technologies as its core programming Page 61 of 75

62 language. Workday utilizes an in-memory database platform that better leverages the code s object relationships. Mobile Strategy: Mobile has been a key Workday strategy for several years. Workday's current mobile functionality features the ability to perform several HR tasks including requesting or approving time off along with managing time against projects with a mobile time clock. Employees can also access their personal activity streams and managers can approve expense reports. Workday HCM Workday HCM is the company s flagship product and comprises the majority of current revenues. Workday s approach to HR software has been different than more other new recent entrants into the space having started its suite with core HRMS and payroll functionality versus easier to build Talent Management applications. Workday HCM has become the first truly global, SaaS-based HRMS platform that also includes complete payroll functionality for U.S., Canadian and U.K. employees, with payroll for France currently under development. Workday has also begun expanding its HCM suite outside of just core HRMS and payroll functionality. Workday HCM today also offers Talent Management functionality for Recruiting, Onboarding, Performance Management, Goals Management, Time & Attendance, and Succession Management. We also expect the company to organically develop a Learning Management system in the near future. Exhibit #45 below further details Workday s current HCM product suite. Figure 45 Workday HCM Suite Source: Company data, Needham & Company, LLC Workday Financial Management Workday Financial Management represents the company s newest large target market opportunity. While it was introduced in 2007, we believe the solution set is just beginning to experience broader adoption. Workday Financial Management contains all the typical functional requirements of a financial accounting software application including general ledger, AP, AR, and complex reporting needs. It also contains revenue management, cash management abilities, expense management, procurement, and transaction level control through its Governance, Risk, and Page 62 of 75

63 Compliance capabilities. Areas of new capabilities we believe to be on the company s current product roadmap include supply chain management and advanced capabilities for manufacturing customers. Exhibit #46 below further details the Workday Financial Management application. Figure 46 Workday Financials Suite Source: Company data, Needham & Company, LLC While sales of the company s financial platform had been slow the first several years on the market as the company developed additional functionality to broaden the platform, sales have accelerated over the past year. The company has sold over 135 financials deals and recently went live with its 50 th customer, which includes three customers in EMEA and one in APAC. Sales of the company s financials platform have not been a significant contributor to its revenue growth to date, but we believe could be its largest driver by CY17. Integrated Big Data analytics through Insight Applications Workday has also delivered on its Big Data project with a new analytics platform called Insight Applications. Insight Applications leverages the power of advanced data science and machine learning to give organizations the opportunity to make smarter financial and workforce decisions through prescriptive analytics. The company recently released its first Insight Application called Talent Insights used to help predict which employees might involve retention risk. We expect the company to release several additional Insight Applications that are purpose-built to yield insight into several functional areas. Workday Student Workday has undertaken the development of a modern Cloud-based platform to manage the back-office complexities of higher education institutions. Called Workday Student, the company released its first application on the platform in late 2014 for student recruiting and we believe the complete platform remains on track for completion by the end of CY16. The complete platform will allow higher education institutions to manage admissions, registrations, financial awards, student-aid, tuition management, and graduation along with the already released student recruiting. Page 63 of 75

64 Figure 47 Workday Student Suite Source: Company data, Needham & Company, LLC Workday People David Duffield - Chairman of the Board Mr. Duffield co-founded Workday in 2005, serving as CEO from 2005 to September 2009 and then as co-ceo from September 2009 until Mr. Duffield brought Workday significant enterprise software company experience, most notably founding PeopleSoft, Inc. and serving as its CEO from 1987 to Prior to founding PeopleSoft, Mr. Duffield also founded Integral Systems, Inc., co-founded Information Associates, and also worked at IBM. Mr. Duffield earned a Bachelor of Science in Electrical Engineering and a Masters of Business Administration from Cornell University. Aneel Bhusri - Chief Executive Officer and Director Mr. Bhusri co-founded Workday and served as co-ceo from September 2009 until being named as CEO in He served as Chairman of the Board from January 2012 to Prior to co-founding Workday, Mr. Bhusri held several senior level positions with PeopleSoft including Senior Vice President, Product Strategy, Marketing and Business Development. Mr. Bhusri earned a Bachelor of Science in Electrical Engineering and a Bachelor of Arts from Brown University and a Master in Business Administration from Stanford University. Mark Peek - Chief Financial Officer Mr. Peek joined Workday in June 2012 as Chief Financial Officer and has served in the position since. Mr. Peek was also previously a Director from December 2011 until June Prior to joining Workday, Mr. Peek was Chief Financial Officer and Co- President, Business operations of VMware, Inc., serving as CFO from 2007 until Prior to joining VMware, Mr. Peek held several senior management positions with Amazon.com and was a partner with Deloitte & Touche LLP. Mr. Peek earned a Bachelor of Science in Accounting and Business Administration from Minnesota State University. Michael Stankey - President and Chief Operating Officer Page 64 of 75

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