SaaS/Application Software

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May 19, 2015 Sector Chart Nasdaq (NDA) 05/19/15 4,800.00 4,600.00 4,400.00 4,200.00 4,000.00 3,800.00 3,600.00 3,400.00 3,200.00 Ju n-14 Ju l-1 4 A ug -1 4 S ep -1 4 O ct -1 4 N ov-14 D ec-14 Ja n-15 Fe b-15 M ar -1 5 A pr -1 5 M ay-15 Price

Topic of Discussion:

Human Capital Management (HCM) software space

Contributing Analysts Scott Berg (763) 350-4027 [email protected]

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)

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.

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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 2015. The company’s current EV/revenue valuation of 3.7x FY16 revenues remains at a 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.

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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 2020.

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.

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Figure 1 The Evolution of HR

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.

Current HCM

Technology

Current Internal

Processes

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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.

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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.

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Figure 3 Primary Human Capital Management Suite Components

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.

Workforce Planning (Analytics)

Recruitment Performance Learning Management (LMS)

HRMS Transaction Systems and Payroll

• Applicant Tracking • Onboarding • Social Sourcing • Candidate CRM • Structured Training • Social Learning • Extended Learning • Goals Management • Performance • Management • Succession Management • Compensation Management

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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

Source: Company data, Needham & Company, LLC

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

HRMS (License) HRMS (Multi-tenant SaaS) HRMS (Hosted License) Time & Attendance Payroll Recruiting Software Performance Management Compensation Management Succession Management Learning Management Social 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

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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 mid-single 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:

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• 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

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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 $1.5-2.0B 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 2016. 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 2014. 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%

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growth through 2014. 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

Source: Forrester

2009

2010

2011

2012

2013 2014E

CAGR

HRMS

3,980

4,348

4,740

5,119

5,477

5,915

8.2%

Performance

management

555

637

739

864

994

1,193

16.5%

Learning

management

440

483

526

563

602

645

7.9%

Recruiting

906

987

1,056

1,151

1,231

1,330

8.0%

Compensation

and benefits

782

835

902

965

1,033

1,095

7.0%

Total

6,663

7,290

7,963

8,662

9,337

10,178

8.3%

1,000 2,000 3,000 4,000 5,000 6,000 2009 2010 2011 2012 2013 2014E HRMS Performance management Learning management Recruiting Compensation and benefits

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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 2016. 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 2015. 1Q 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

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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

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

0 250 500 750 1000 1250 1500 1750 2000

Learning Performance Succession Connect Compensation Recruiting Onboarding Existing Client Penetration Client opportunity

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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 2010. 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 2005. 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, 2014.

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 2009. 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 2013.

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 2007.

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Figure 8 CSOD Customer Count since 2007 Figure 9 CSOD Seat Count since 2007

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.

105 168 280 481 805 1,237 1,631 2,153 500 1,000 1,500 2,000 2,500 2007 2008 2009 2010 2011 2012 2013 2014 0.9 2.1 3.3 4.9 7.5 10.6 14.0 18.1 0.0 2.0 4.0 6.0 8.0 10.0 12.0 14.0 16.0 18.0 20.0 2007 2008 2009 2010 2011 2012 2013 2014 M ill io n s

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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

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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.

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Figure 11 Cornerstone Revenue vs. Operating Margins

Source: Company reports and Needham & Company, LLC estimates

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

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, 2018. They bear an interest rate of 1.5% per year and have certain call features. The bonds convert for 18.50 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. $11 $20 $29 $47 $76 $119 $185 $264 $340 $432 -70.0% -60.0% -50.0% -40.0% -30.0% -20.0% -10.0% 0.0% $50 $100 $150 $200 $250 $300 $350 $400 $450 $500 2007 2008 2009 2010 2011 2012 2013 2014 2015E 2016E M ill ion s Revenue Operating Margins 2008 2009 2010 2011 2012 2013 2014 2015E 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%

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Figure 13 Cornerstone OnDemand Income Statement

Needham & Company, LLC

Income Statement 2007 2008 2009 2010 2011 2012 2013 1Q 2Q 3Q 4Q 2014 1Q 2QE 3QE 4QE 2015E 1QE 2QE 3QE 4QE 2016E

Total Revenues 10,976 19,626 29,322 46,608 75,522 119,354 185,298 57,409 61,468 68,318 76,828 264,023 74,435 80,093 87,447 97,572 339,546 98,254 102,519 109,309 121,964 432,046 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 32,443 116,134 Gross Profit 7,089 13,540 20,673 32,397 54,788 87,332 135,326 41,119 44,958 49,909 55,805 191,791 53,084 58,628 64,011 70,935 246,658 71,333 75,044 80,014 89,522 315,912 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 41,151 143,722 41,238 45,252 45,472 51,225 183,188 53,549 57,411 57,934 63,422 232,314

% 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 67,515 102,782 144,910 45,138 49,358 49,793 57,779 202,068 58,883 63,113 63,574 69,861 255,431 74,673 79,913 80,889 87,083 322,558

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% -102.3% -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 20 62 72 137 181 175 614 153 200 178 324 855 278 200 200 200 878 200 200 200 200 800

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% -196.6% -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 20 62 72 137 181 175 614 153 200 178 324 855 278 200 200 200 878 200 200 200 200 800

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% -105.4% -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% -447.6% -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 8562 8387 8467 9,206 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 - 14,361 131,072 139,712 153,467 191,336 180,856

CFO - (5,986) (1,633) 1,705 1,832 10,295 17,431 879 (8,157) (4,153) 44,440 33,009 (2,650)

Cash Balance - 3,290 8,061 309,135 296,024 287,670 286,601 273,687

Cash/Share n/a n/a n/a 6.72 6.44 6.25 6.23 5.95

Scott Berg, [email protected] Source: Company Reports and Needham & Company Estimates

763.350.4027 $ in thousands, except per share data

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Figure 14 Cornerstone OnDemand Balance Sheet

Needham & Company, LLC

Balance Sheet 2011 2012 2013 1Q 2Q 3Q 4Q 2014 1Q 2QE 3QE 4QE 2015E 1QE 2QE 3QE 4QE 2016E

Assets

Cash and equivalents 85,409 76,442 109,583 108,685 96,578 103,994 166,557 166,557 86,648 70,059 65,284 117,700 117,700 112,041 83,037 85,565 148,800 148,800 Short Term Investments 199,925 184,421 145,183 123,793 116,106 116,106 133,449 133,449 133,449 133,449 133,449 133,449 133,449 133,449 133,449 133,449 Accounts receivables 34,110 47,528 67,191 52,545 69,128 86,856 84,499 84,499 61,392 92,107 104,936 102,450 102,450 90,394 112,771 120,240 124,404 124,404 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 126,845 141,573 407,451 373,488 342,626 348,215 406,405 406,405 322,032 333,258 343,020 398,482 398,482 381,081 374,365 386,256 459,098 459,098 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 748 227 5,978 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 135,362 171,834 451,355 436,518 446,462 459,322 505,655 505,655 471,625 482,838 490,194 546,628 546,628 529,014 524,151 536,232 611,893 611,893

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 87,759 135,322 129,226 136,147 148,057 180,598 180,598 168,352 172,200 185,388 229,293 229,293 225,985 220,415 240,479 298,813 298,813 Capital lease obligations, current 1,617 1,643 905 683 557 416 236 236 141 141 141 141 141 1,702 1,702 1,702 1,702 1,702 Debt, current - 916 519 503 469 403 351 351 228 228 228 228 228 228 228 228 228 228 Other liabilities 1,261

SaaS/Application Software

Topic of Discussion:

HCM 2020: Collaborative, Connected, and Converging

Table of Contents

Trends driving the HCM demand into 2020

Driver #1: Unified Suites Are Winning, Sort Of

Driver #3: Mobile use highest in HCM than any other Enterprise Software segment, but adoption remains in the early stages

Current HCM

Driver #5: The Book on HCM Software Has Yet to be Completed . . . Innovation Levels Healthy

Market Overview

Figure 2 Evolution of HR Software

Competitors

Workforce Planning (Analytics)

Recruitment Performance Learning Management (LMS)

HRMS Transaction Systems and Payroll

Figure 4 HCM Vendor Market Share by Revenues

Performance Management Software

Learning Management Systems

HCM Software Market Opportunity

Performance

Valuation

Figure 7 Cornerstone Product Penetration Rates

Investment Concerns

Company Overview

Figure 8 CSOD Customer Count since 2007 Figure 9 CSOD Seat Count since 2007

Cornerstone OnDemand Products

Figure 10 Cornerstone Products

People – Cornerstone OnDemand Management

Financials

FY15 Income Statement Overview

Figure 11 Cornerstone Revenue vs. Operating Margins

Cash Flow

Figure 12 Cornerstone Cash Flow Estimates

Balance Sheet

Figure 13 Cornerstone OnDemand Income Statement

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)

Figure 14 Cornerstone OnDemand Balance Sheet

Liabilities and Equity