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Online Research: www.research-driven.com Research: (800) 866-3272 • Trading: (800) 322-3272 • (312) 258-0660 One South Wacker Drive • Suite 3900 • Chicago, IL 60606 Important disclosures and certifications begin on page 20 of this report Contents SaaS stock performance chart by sector 2 Front-page commentary continued 3 SaaS financial and valuation comparisons 8 First Analysis sector-specific discussions Human Capital Technology 11 Healthcare Analytics 13 IoT/M2M 14 Cyber Security 16 e-Commerce Optimization 17 Other SaaS 19 (Continued on page 3) SaaS October 2, 2017 QUARTERLY INSIGHTS Rule of 40 a better predictor of valuation than just revenue growth ■ The Rule of 40 was developed as a gate to determine the best SaaS performers, and using the specific numerical result of adding revenue growth and EBITDA margin is a better predictor of valuation (with a correlation of 0.74) than just revenue growth alone (correlation 0.55) for 2017 data. Twelve of our 34 SaaS names (35.3%) with 2017 data meet the Rule of 40 criteria. ■ Our SaaS universe continued to outperform the S&P 500 in the September quarter with a median gain of 7.9% compared to 4.0% for the market index. Performance was much more vari- able by stock and sector than last quarter, supporting the value of individual stock selection. ■ Using regression analysis for our SaaS universe, the 2017 correlation improves to 0.85 by weighting revenue growth at approximately twice the EBITDA margin. This supports our view that revenue growth is the most important factor for SaaS valu- ations. We call this weighted formula the First Analysis Rule of 40. Rule of 40 The Rule of 40 appears to have been popularized by noted blogger and investor Brad Feld in a post on Feb. 3, 2015. The concept has quickly taken off since then. Feld apparently heard about the con- cept from another late-stage investor at a board meeting. Simply, INTEGRATIVE PUBLIC/PRIVATE PERSPECTIVE SaaS companies by sector Sector coordinator: James Macdonald Human Capital Corey Greendale James Macdonald Ken Wang 312.258.7139 312.258.7124 312.258.7193 BlackLine Inc. BL Callidus Software Inc. CALD Cornerstone OnDemand Inc. CSOD Coupa Software Inc. COUP Instructure Inc. INST Paycom Software Inc. PAYC Paylocity Holding Corp. PCTY 2U Inc. TWOU Ultimate Software Group Inc. ULTI Workday Inc. WDAY e-Commerce optimization David Gearhart Larry Berlin 312.258.7128 312.258.7187 ChannelAdvisor Corp. ECOM CommerceHub Inc. CHUBA Five9 Inc. FIVN HubSpot Inc. HUBS LivePerson Inc. LPSN RingCentral Inc. RNG salesforce.com CRM SPS Commerce Inc. SPSC Zendesk Inc. ZEN Other SaaS Alteryx Inc. AYX Atlassian Corp. PLC TEAM Everbridge Inc. EVBG LogMeIn Inc. LOGM MuleSoft Inc. MULE New Relic Inc. NEWR ServiceNow Inc. NOW Healthcare Analytics Frank Sparacino 312.258.7103 athenahealth Inc. ATHN Benefitfocus Inc. BNFT Castlight Health Inc. CSLT Medidata Solutions Inc. MDSO Veeva Systems Inc. VEEV IoT/M2M Howard Smith David Gearhart 312.258.7117 312.258.7128 Alarm.com Holdings Inc. ALRM MiX Telematics Ltd. MIXT Cyber Security Howard Smith David Vercoutere 312.258.7117 312.258.7114 Proofpoint Inc. PFPT Qualys Inc. QLYS (800) 866-3272 2 First Analysis Securities Corporation SaaS Quarterly Insights October 2, 2017 Our SaaS universe continued to outperform the S&P 500 in the June quarter with a median return of 7.9% compared to 4.0% for the S&P. Performance was significantly more variable by sector in the September quarter after very similar performance in the June quarter as shown in the chart below. The Healthcare sector was down 7.4% in the September quarter after having the biggest gains last quarter; it was the only sector showing a decline. The largest gaining sectors were IoT, up 23.0%, and Cyber Security, up 13.7%. The large Human Capital and e-Commerce sectors were up 8.4% and 11.1%, respectively. Individual stocks also had wide variation. CommerceHub was the larg- est gainer, up 29.6%; First Analysis picked up coverage during the quarter. Qualys was up 27.0%. MuleSoft was the largest decliner, down 19.6%. Benefitfocus, athenahealth, and Veeva all declined significantly, leading to the weak Healthcare performance. We removed Xactly from our SaaS uni- verse after it was acquired by Vista Equity. Commentary Quarterly SaaS company performance SaaS Stock Performance by Sector (equal-weighted) 75% 80% 85% 90% 95% 100% 105% 110% 115% 120% 125% 3/31/2017 4/30/2017 5/31/2017 6/30/2017 7/31/2017 8/31/2017 9/30/2017 Human Capital Healthcare Analytics IoT/M2M Cyber Security E-Commerce Optimization Others SaaS Overall SaaS Group S&P 500 Source: First Analysis, FactSet. (800) 866-3272 3 First Analysis Securities Corporation SaaS Quarterly Insights October 2, 2017 the Rule of 40 is that a well performing software or SaaS company should have revenue growth and profitability percentage that add up to over 40% (we will refer to this calculated number as R40). So if you are growing at 40%, you should be breakeven or better. If you are growing 50%, you can be losing 10%. Most pundits use EBITDA margin, which is what we will use for this report, but others prefer cash flow margin or other profitability measures. The Rule of 40 was originally conceived for companies with over $50 million in revenue, but Feld believes it applies to companies as small as $1 million. One application is to decide how much to invest (or how much money to lose) in early venture-backed companies. The calculation has also been applied to public com- panies. Data presented by venture capitalist Tomasz Tunguz in 2015 for a group of public SaaS companies including several original SaaS companies that have been acquired (not our current SaaS universe, Table 1) seems to indicate it be- comes more difficult to reach the 40% hurdle as companies are older and larger. He notes that year 5 or 6 after founding typically represents around $50 million in revenue for these companies and also represents the period these companies have an R40 average close to 40%. In fact, early in their lifetime these soon-to- be public companies were well above the 40% threshold primarily because they were growing very quickly (often doubling or tripling each year). We have been writing for several years that we believe revenue growth is the most important single determinant in SaaS valuations. We also published a report on June 30, 2015, about how profitability was becoming more important in valuations. Our impression in the early SaaS days (~2002-08 time period) was that SaaS companies did not want to be profitable so they would continue to be valued on a price-to-sales ratio rather than P/E. Since both revenue growth rate and profitability are clearly important, we decided to see if the R40 calculation had better correlation with valuation—and it does! In Table 2, we list our SaaS universe in order of highest 2017 R40 to lowest. Twelve of our 34 SaaS companies (35.3%, excluding LogMeIn) are expected to (Continued from page 1) TABLE 1 Median R40 by Year Since Founding for SaaS Public Companies 0% 30% 60% 90% 120% Ratio4 8 12 16 Years Since Founding Source: tomtunguz.com/rule-of-40, Feb. 11, 2015. (800) 866-3272 4 First Analysis Securities Corporation SaaS Quarterly Insights October 2, 2017 TABLE 2 Ranking of SaaS Companies by Rule of 40 and First Analysis Rule of 40 **=currently covered by FA Rule of 40 First Analysis Rule of 40 Revenue Growth Adjusted EBITDA EV/Sales Company 2017e 2018e 2017e 2018e 2017e 2018e 2017e 2018e 2017e 2018e Atlassian (TEAM) 62.4% 60.4% 65.3% 63.0% 35.6% 34.0% 26.7% 26.4% 11.6 8.6 Paycom Software (PAYC)** 59.3% 54.3% 59.8% 52.9% 30.4% 25.0% 28.9% 29.2% 10.1 8.1 ServiceNow (NOW) 59.0% 55.2% 64.1% 57.2% 37.2% 30.5% 21.8% 24.7% 9.7 7.4 Veeva Systems (VEEV) 56.9% 51.6% 53.8% 47.4% 23.8% 19.5% 33.1% 32.1% 11.5 9.6 CommerceHub (CHUBA)** 52.4% 55.4% 43.3% 46.8% 12.6% 14.8% 39.8% 40.6% 8.9 7.8 Workday (WDAY)** 49.2% 42.7% 55.4% 45.5% 33.9% 25.7% 15.3% 17.0% 9.1 7.3 Paylocity (PCTY)** 48.8% 42.6% 52.5% 43.8% 30.0% 23.2% 18.7% 19.4% 7.5 6.1 Qualys (QLYS)** 48.1% 50.0% 42.1% 43.9% 15.0% 15.9% 33.0% 34.1% 7.7 6.6 Proofpoint (PFPT)** 46.5% 41.9% 54.1% 46.8% 34.7% 28.3% 11.8% 13.6% 9.5 7.4 Salesforce.com (CRM) 45.9% 42.9% 46.5% 41.8% 23.8% 19.8% 22.0% 23.1% 6.3 5.3 Medidata Solutions (MDSO) 44.0% 43.9% 42.4% 41.4% 19.5% 18.2% 24.5% 25.7% 7.9 6.7 Ultimate Software (ULTI) 42.9% 44.1% 41.8% 42.7% 19.8% 20.0% 23.0% 24.1% 5.9 4.9 Zendesk Inc. (ZEN) 39.0% 34.8% 49.7% 43.0% 35.6% 29.7% 3.4% 5.1% 5.9 4.5 HubSpot (HUBS) 38.9% 32.4% 48.8% 38.8% 34.4% 25.8% 4.5% 6.5% 6.8 5.4 BlackLine (BL) 38.1% 31.4% 51.9% 40.4% 39.8% 29.2% -1.7% 2.2% 9.4 7.3 RingCentral Inc. (RNG) 36.1% 31.2% 43.9% 36.6% 29.7% 23.7% 6.4% 7.5% 5.7 4.6 2U Inc. (TWOU)** 35.2% 39.8% 44.4% 49.4% 31.4% 1 34.4% 1 3.8% 5.4% 8.4 6.2 Athenahealth (ATHN)** 34.6% 36.3% 31.9% 33.2% 13.2% 13.5% 21.4% 22.7% 4.2 3.7 Alarm.com (ALRM)** 34.2% 35.0% 32.1% 31.8% 13.9% 1 12.7% 1 20.3% 22.3% 6.5 5.7 New Relic (NEWR)** 34.1% 34.7% 43.8% 40.5% 31.6% 26.1% 2.5% 8.6% 6.6 5.2 Everbridge (EVBG) 31.9% 27.1% 43.5% 35.4% 33.4% 26.0% -1.5% 1.2% 6.3 5.0 Callidus Software (CALD) 31.2% 33.8% 33.7% 35.3% 19.4% 19.1% 11.8% 14.7% 5.6 4.7 MiX Telematics (MIXT)** 30.3% 34.7% 24.7% 28.8% 6.8% 8.5% 23.4% 26.2% 1.6 1.5 SPS Commerce (SPSC)** 28.1% 30.2% 27.7% 29.8% 13.5% 14.5% 14.6% 15.7% 3.7 3.2 Five9 (FIVN) 26.5% 26.1% 31.0% 29.1% 20.1% 17.5% 6.4% 8.6% 6.1 5.2 Alteryx (AYX) 24.0% 18.4% 46.9% 36.2% 46.3% 35.9% -22.2% -17.5% 7.6 5.6 MuleSoft (MULE) 23.8% 10.2% 48.7% 29.8% 49.3% 34.5% -25.5% -24.3% 8.3 6.2 Instructure (INST)** 18.8% 21.3% 38.3% 34.3% 38.6% 30.1% -19.8% -8.8% 5.9 4.5 Benefitfocus (BNFT)** 16.2% 23.5% 17.4% 25.2% 10.0% 14.3% 6.2% 9.2% 3.9 3.4 Cornerstone OnDemand (CSOD)** 15.4% 21.2% 19.4% 24.6% 13.7% 15.6% 1.7% 5.6% 4.4 3.8 ChannelAdvisor (ECOM)** 14.8% 18.3% 16.2% 19.8% 9.6% 11.3% 5.2% 6.9% 1.9 1.7 Coupa Software (COUP)** 13.6% 9.0% 31.3% 22.4% 33.4% 24.6% -19.7% -15.6% 7.8 6.3 Castlight Health (CSLT)** 6.3% 18.7% 24.6% 30.9% 30.7% 27.6% -24.4% -8.9% 3.4 2.7 LivePerson (LPSN)** 5.9% 17.7% 1.7% 16.5% -3.4% 7.0% 9.3% 10.7% 3.3 3.1 LogMeIn (LOGM) na 52.9% na 45.1% na 14.8% 35.4% 38.1% 5.5 4.8 Source: First Analysis, FactSet, company reports; EV/sales as of Sept. 25. Notes: 1 First Analysis estimates, excluding acquisition (800) 866-3272 5 First Analysis Securities Corporation SaaS Quarterly Insights October 2, 2017 meet the 40% threshold in 2017. These 12 companies are not just the smaller SaaS companies but include the three largest ones, salesforce.com, Workday, and ServiceNow. Looking at the data for these 12 companies, the strong R40 results are supported by strong profitability, with the lowest adjusted EBITDA margin in the group at 11.8% (for Proofpoint). Nine of the 12 companies have over 20% EBITDA margin and three of the 12 have over 30% EBITDA margin. With these profitability levels, we would expect many of these companies to maintain an R40 over 40% even when revenue growth drops below our 20% SaaS threshold. We were somewhat surprised that no loss-making companies in our SaaS universe are growing fast enough to have an R40 over 40%. Based on consensus estimates for 2018, this entire group of companies is ex- pected to continue to have an R40 over 40% next year. LogMeIn is also expected to be added to this group after the acquisition of GetGo Inc., a division of Citrix, is anniversaried. Rule of 40 improves correlation with valuation In Tables 3 and 4, we plot our traditional 2017 revenue growth versus valuation (EV/2017 revenue) and the new 2017 R40 versus EV/2017 revenue, respectively. Valuation correlates better with R40 (0.74) than with revenue growth alone (0.55). As noted, as the SaaS sector matures, profitability is becoming more important, but we still view revenue growth as the most important single driver of valuation. As with our work on revenue growth, we would look at companies below the trendline in Table 4 as mathematically undervalued. We would look closely at those companies with an R40 near or over 40% with lower revenue multiples including Ultimate Software (5.8x 2017 revenue), salesforce.com (6.4x 2017 revenue), and Zendesk (5.8x 2017 revenue, R40 of 38.4%). A better measure: “First Analysis R40” We did a regression analysis and found the best correlation to describe current stock valuation (EV/revenue) was using a weighting of 65/35 for revenue growth and EBITDA margin for 2017 and a weighting of 69/31 for 2018. This improves the correlation to 0.85 for 2017 from 0.74 (see Table 5). Based on this, we are proposing an optimized calculation we call “First Analysis R40,” which is 1.333X revenue growth and 0.667X EBITDA margin. Clearly, this helps fast-growing companies with low margins like Alteryx, which has a First Analysis R40 of 46.9%, up from 24.0%, and MuleSoft would increase to 48.7% from 23.8% for 2017. 21 of 33 companies (63.6%) in our SaaS universe would be over 40% under this rule. (800) 866-3272 6 First Analysis Securities Corporation SaaS Quarterly Insights October 2, 2017 TABLE 4 EV/'17e Sales vs. Rule of 40 LPSN CRM RNG ZEN SPSC ALRM MIXT ATHN MDSO VEEV CSOD ULTI WDAY CSLT PCTY PAYC BNFT CALD INST NOW NEWR TWOU HUBS ECOM PFPT QLYS EVBG TEAM BL COUP FIVN CHUBA MULE AYX 0.0 2.0 4.0 6.0 8.0 10.0 12.0 14.0 0.0% 10.0% 20.0% 30.0% 40.0% 50.0% 60.0% 70.0% Correlation: 0.74 Source: First Analysis, FactSet, company reports. Notes: Excludes LOGM. TABLE 3 EV/'17e Sales vs. Revenue Growth CRM RNG ZEN SPSC ALRM MIXT ATHN MDSO VEEV CSOD ULTI WDAY CSLT PCTY PAYC BNFT CALD INST NOW NEWR TWOU HUBS ECOM PFPT QLYS EVBG TEAM BL COUP FIVN CHUBA MULE AYX 0.0 2.0 4.0 6.0 8.0 10.0 12.0 14.0 0.0% 10.0% 20.0% 30.0% 40.0% 50.0% 60.0% Correlation: 0.55 Source: First Analysis, FactSet, company reports. Notes: Excludes LOGM, LPSN. (800) 866-3272 7 First Analysis Securities Corporation SaaS Quarterly Insights October 2, 2017 TABLE 5 EV/'17e Sales vs. First Analysis Rule of 40 LPSN CRM RNG ZEN SPSC ALRM MIXT ATHN MDSO VEEV CSOD ULTI WDAY CSLT PCTY PAYC BNFT CALD INST NOW NEWR TWOU HUBS ECOM PFPT QLYS EVBG TEAM BL COUP FIVN CHUBA MULE AYX 0.0 2.0 4.0 6.0 8.0 10.0 12.0 14.0 0.0% 10.0% 20.0% 30.0% 40.0% 50.0% 60.0% 70.0% Correlation: 0.85 Source: First Analysis, FactSet, company reports. Notes: Excludes LOGM. October 2, 2017SaaS Quarterly InsightsSaaS Comparisons (Source: First Analysis, FactSet estimates)(800) 866-32728First Analysis Securities CorporationCompany ** = Currently covered by FA 2017e Rev ($M) 2018e Rev ($M) 2017e/2016 Rev. Growth 2018e/2017e Rev. Growth 2017e Gross Margin 2018e Gross Margin 2017e Op. Margin 2018e Op. Margin Enterprise Value ($M) EV/'17e Sales EV/'18e Sales 2017e EV/ EBITDA 2018e EV/ EBITDA 2017e P/E 2018e P/E Human Capital BlackLine Inc. (BL) $172.1 $222.4 39.8% 29.2% 80.3% 79.9% -5.3% -2.4% $1,660.2 9.6 7.5 na na na na Callidus Software Inc. (CALD) $246.8 $293.9 19.4% 19.1% 63.7% 65.6% 9.2% 11.2% $1,432.3 5.8 4.9 49.2 33.1 77.0 61.6 Cornerstone OnDemand, Inc. (CSOD)** $481.2 $556.5 13.7% 15.6% 72.4% 72.8% 5.9% 9.6% $2,245.3 4.7 4.0 273.8 72.2 104.1 54.9 Coupa Software Inc. (COUP)** $178.4 $222.3 33.4% 24.6% 69.3% 72.6% -14.2% -8.1% $1,433.3 8.0 6.4 na na na na Instructure, Inc. (INST)** $153.7 $200.0 38.6% 30.1% 72.2% 73.4% -25.0% -12.9% $938.6 6.1 4.7 na na na na Paycom Software, Inc. (PAYC)** $429.1 $536.5 30.4% 25.0% 83.8% 83.8% 24.3% 24.2% $4,374.1 10.2 8.2 35.2 27.9 64.6 52.1 Paylocity Holding Corp. (PCTY)** $300.0 $369.6 30.0% 23.2% 62.6% 63.6% 10.8% 11.6% $2,416.1 8.1 6.5 43.0 33.7 72.9 61.0 2U, Inc. (TWOU)** $284.2 $390.1 38.0% 37.3% 82.3% 81.2% -10.9% -8.9% $2,549.9 9.0 6.5 238.3 122.0 na na The Ultimate Software Group, Inc. (ULTI) $936.1 $1,123.3 19.8% 20.0% 63.7% 64.6% 19.2% 20.1% $5,705.8 6.1 5.1 26.5 21.1 53.7 43.3 Workday, Inc. (WDAY)** $2,101.4 $2,640.4 33.9% 25.7% 73.6% 74.8% 6.9% 8.9% $20,265.7 9.6 7.7 63.0 45.1 127.0 96.7 Average: 29.7% 25.0% 72.4% 73.2% 2.1% 5.3% 7.7 6.1 104.2 50.7 83.2 61.6 Median: 31.9% 24.8% 72.3% 73.1% 6.4% 9.2% 8.0 6.5 49.2 33.7 74.9 58.0 Healthcare Analytics athenahealth, Inc. (ATHN)** $1,225.8 $1,391.5 13.2% 13.5% 63.8% 63.7% 10.6% 12.5% $5,245.4 4.3 3.8 20.0 16.6 64.8 50.6 Benefitfocus, Inc. (BNFT)** $256.6 $293.2 10.0% 14.3% 53.2% 54.9% 0.6% 3.7% $1,099.2 4.3 3.7 68.7 40.6 na 420.6 Castlight Health, Inc. (CSLT)** $132.9 $169.6 30.7% 27.6% 68.4% 70.5% -24.0% -9.5% $465.4 3.5 2.7 na na na na Medidata Solutions, Inc. (MDSO) $553.7 $654.4 19.5% 18.2% 77.3% 77.5% 11.0% 12.8% $4,571.5 8.3 7.0 33.6 27.2 61.0 51.4 Veeva Systems Inc. (VEEV) $673.6 $804.7 23.8% 19.5% 70.8% 71.2% 30.0% 30.6% $7,951.3 11.8 9.9 35.7 30.8 65.6 55.9 Average: 19.4% 18.6% 66.7% 67.5% 5.6% 10.0% 6.4 5.4 39.5 28.8 63.8 144.6 Median: 19.5% 18.2% 68.4% 70.5% 10.6% 12.5% 4.3 3.8 34.7 29.0 64.8 53.6 IoT/M2M Alarm.com Holdings, Inc. (ALRM)** $328.4 $379.9 25.8% 15.7% 66.9% 68.7% 17.1% 19.5% $2,217.6 6.8 5.8 33.3 26.2 46.6 46.6 MiX Telematics Limited (MIXT)** $123.8 $134.3 6.8% 8.5% 67.7% 68.2% 14.9% 17.2% $204.6 1.7 1.5 7.1 5.8 17.7 13.8 Average: 16.3% 12.1% 67.3% 68.5% 16.0% 18.4% 4.2 3.7 20.2 16.0 32.1 30.2 Cyber Security Proofpoint, Inc. (PFPT)** $505.7 $648.7 34.7% 28.3% 76.9% 77.0% 7.4% 9.7% $4,745.9 9.4 7.3 79.2 53.7 134.2 86.4 Qualys, Inc. (QLYS)** $227.7 $263.9 15.0% 15.9% 78.5% 78.8% 24.1% 25.0% $1,769.1 7.8 6.7 23.5 19.7 57.6 50.3 Average: 24.9% 22.1% 77.7% 77.9% 15.7% 17.4% 8.6 7.0 51.4 36.7 95.9 68.3 CRM/e-Commerce ChannelAdvisor Corp. (ECOM)** $124.1 $138.1 9.6% 11.3% 77.8% 77.6% -0.3% 0.9% $246.7 2.0 1.8 38.5 25.7 na 143.8 CommerceHub (CHUBA)** $113.2 $129.9 12.6% 14.8% 79.8% 80.1% 32.9% 35.2% $1,013.9 9.0 7.8 22.5 19.2 47.0 38.9 Five9 Inc. (FIVN) $194.6 $228.7 20.1% 17.5% 59.9% 60.8% 1.7% 3.8% $1,289.7 6.6 5.6 103.2 65.8 na 265.6 HubSpot, Inc. (HUBS) $364.1 $458.1 34.4% 25.8% 80.1% 80.8% 0.4% 2.7% $2,840.5 7.8 6.2 172.2 94.7 na 262.7 LivePerson Inc. (LPSN) $215.2 $230.2 -3.4% 7.0% 74.2% 75.0% 3.5% 3.3% $700.6 3.3 3.0 34.9 28.4 150.6 90.3 RingCentral, Inc. (RNG) $492.6 $609.2 29.7% 23.7% 75.9% 76.3% 2.9% 4.3% $3,001.8 6.1 4.9 95.9 65.6 245.6 139.2 Salesforce.com, Inc. (CRM) $10,392.3 $12,454.1 23.8% 19.8% 76.0% 76.1% 14.1% 15.6% $66,483.5 6.4 5.3 29.1 23.1 71.3 53.7 SPS Commerce, Inc. (SPSC)** $219.3 $251.1 13.5% 14.5% 67.8% 68.3% 11.2% 12.1% $826.9 3.8 3.3 25.8 21.0 66.7 54.0 Zendesk, Inc. (ZEN) $423.0 $548.8 35.6% 29.7% 73.5% 74.0% -4.4% -0.5% $2,656.1 6.3 4.8 185.7 95.5 na na Average: 19.5% 18.2% 73.9% 74.3% 6.9% 8.6% 5.7 4.8 78.6 48.8 116.2 131.0 Median: 20.1% 17.5% 75.9% 76.1% 2.9% 3.8% 6.3 4.9 38.5 28.4 71.3 114.8 Other SaaS Alteryx, Inc. (AYX) $125.5 $170.6 46.3% 35.9% 83.7% 84.4% -14.7% -11.7% $1,034.9 8.2 6.1 na na na na Atlassian Corporation PLC (TEAM) $619.9 $831.0 35.6% 34.0% 83.8% 83.8% 16.8% 17.8% $7,387.0 11.9 8.9 44.6 33.7 97.6 79.9 Everbridge, Inc. (EVBG) $102.5 $129.1 33.4% 26.0% 71.6% 71.8% -7.8% -5.3% $691.6 6.7 5.4 na $461.0 na na LogMeIn, Inc. (LOGM) $1,015.4 $1,165.5 na 14.8% 83.7% 83.3% 29.8% 32.6% $5,656.7 5.6 4.9 15.7 12.7 27.2 22.7 MuleSoft, Inc. (MULE) $280.2 $376.9 49.3% 34.5% 74.4% 74.6% -17.1% -12.5% $2,338.0 8.3 6.2 na na na na New Relic, Inc. (NEWR)** $346.8 $437.2 31.6% 26.1% 82.4% 82.1% -4.3% 2.7% $2,447.0 7.1 5.6 281.3 64.9 na 237.1 ServiceNow, Inc. (NOW) $1,907.6 $2,490.0 37.2% 30.5% 77.0% 78.1% 16.0% 19.4% $19,475.1 10.2 7.8 46.8 31.7 100.5 65.7 Average: 38.9% 28.8% 79.5% 79.7% 2.7% 6.2% 8.3 6.4 97.1 120.8 75.1 101.3 Median: 36.4% 30.5% 82.4% 82.1% -4.3% 2.7% 8.2 6.1 45.7 33.7 97.6 72.8 October 2, 2017SaaS Quarterly InsightsSaaS Comparisons (Source: First Analysis, FactSet estimates)(800) 866-32729First Analysis Securities CorporationCompany ** = Currently covered by FA 2017e Rev ($M) 2018e Rev. ($M) 2017e/2016e Rev. Growth 2018e/2017e Rev. Growth 2017e Gross Margin 2018e Gross Margin 2017e Op. Margin 2018e Op. Margin Enterprise Value ($M) EV/'17e Sales EV/'18e Sales 2017e EV/ EBITDA 2018e EV/ EBITDA 2017e P/E 2018e P/E Salesforce.com, Inc. (CRM) $10,392.3 $12,454.1 23.8% 19.8% 76.0% 76.1% 14.1% 15.6% $66,484 6.4 5.3 29.1 23.1 71.3 53.7 Workday, Inc. (WDAY)** $2,101.4 $2,640.4 33.9% 25.7% 73.6% 74.8% 6.9% 8.9% $20,266 9.6 7.7 63.0 45.1 127.0 96.7 ServiceNow, Inc. (NOW) $1,907.6 $2,490.0 37.2% 30.5% 77.0% 78.1% 16.0% 19.4% $19,475 10.2 7.8 46.8 31.7 100.5 65.7 Veeva Systems Inc. (VEEV) $673.6 $804.7 23.8% 19.5% 70.8% 71.2% 30.0% 30.6% $7,951 11.8 9.9 35.7 30.8 65.6 55.9 Atlassian Corporation PLC (TEAM) $619.9 $831.0 35.6% 34.0% 83.8% 83.8% 16.8% 17.8% $7,387 11.9 8.9 44.6 33.7 97.6 79.9 The Ultimate Software Group, Inc. (ULTI) $936.1 $1,123.3 19.8% 20.0% 63.7% 64.6% 19.2% 20.1% $5,706 6.1 5.1 26.5 21.1 53.7 43.3 LogMeIn, Inc. (LOGM) $1,015.4 $1,165.5 na 14.8% 83.7% 83.3% 29.8% 32.6% $5,657 5.6 4.9 15.7 12.7 27.2 22.7 athenahealth, Inc. (ATHN)** $1,225.8 $1,391.5 13.2% 13.5% 63.8% 63.7% 10.6% 12.5% $5,245 4.3 3.8 20.0 16.6 64.8 50.6 Proofpoint, Inc. (PFPT)** $505.7 $648.7 34.7% 28.3% 76.9% 77.0% 7.4% 9.7% $4,746 9.4 7.3 79.2 53.7 134.2 86.4 Medidata Solutions, Inc. (MDSO) $553.7 $654.4 19.5% 18.2% 77.3% 77.5% 11.0% 12.8% $4,571 8.3 7.0 33.6 27.2 61.0 51.4 Paycom Software, Inc. (PAYC)** $429.1 $536.5 30.4% 25.0% 83.8% 83.8% 24.3% 24.2% $4,374 10.2 8.2 35.2 27.9 64.6 52.1 RingCentral, Inc. (RNG) $492.6 $609.2 29.7% 23.7% 75.9% 76.3% 2.9% 4.3% $3,002 6.1 4.9 95.9 65.6 245.6 139.2 HubSpot, Inc. (HUBS) $364.1 $458.1 34.4% 25.8% 80.1% 80.8% 0.4% 2.7% $2,841 7.8 6.2 172.2 94.7 na 262.7 Zendesk, Inc. (ZEN) $423.0 $548.8 35.6% 29.7% 73.5% 74.0% -4.4% -0.5% $2,656 6.3 4.8 185.7 95.5 na na 2U, Inc. (TWOU)** $284.2 $390.1 38.0% 37.3% 82.3% 81.2% -10.9% -8.9% $2,550 9.0 6.5 238.3 122.0 na na New Relic, Inc. (NEWR)** $346.8 $437.2 31.6% 26.1% 82.4% 82.1% -4.3% 2.7% $2,447 7.1 5.6 281.3 64.9 na 237.1 Paylocity Holding Corp. (PCTY)** $300.0 $369.6 30.0% 23.2% 62.6% 63.6% 10.8% 11.6% $2,416 8.1 6.5 43.0 33.7 72.9 61.0 MuleSoft, Inc. (MULE) $280.2 $376.9 49.3% 34.5% 74.4% 74.6% -17.1% -12.5% $2,338 8.3 6.2 na na na na Cornerstone OnDemand, Inc. (CSOD)** $481.2 $556.5 13.7% 15.6% 72.4% 72.8% 5.9% 9.6% $2,245 4.7 4.0 273.8 72.2 104.1 54.9 Alarm.com Holdings, Inc. (ALRM)** $328.4 $379.9 25.8% 15.7% 66.9% 68.7% 17.1% 19.5% $2,218 6.8 5.8 33.3 26.2 46.6 46.6 Qualys, Inc. (QLYS)** $227.7 $263.9 15.0% 15.9% 78.5% 78.8% 24.1% 25.0% $1,769 7.8 6.7 23.5 19.7 57.6 50.3 BlackLine Inc. (BL) $172.1 $222.4 39.8% 29.2% 80.3% 79.9% -5.3% -2.4% $1,660 9.6 7.5 na na na na Coupa Software Inc. (COUP)** $178.4 $222.3 33.4% 24.6% 69.3% 72.6% -14.2% -8.1% $1,433 8.0 6.4 na na na na Callidus Software Inc. (CALD) $246.8 $293.9 19.4% 19.1% 63.7% 65.6% 9.2% 11.2% $1,432 5.8 4.9 49.2 33.1 77.0 61.6 Five9 Inc. (FIVN) $194.6 $228.7 20.1% 17.5% 59.9% 60.8% 1.7% 3.8% $1,290 6.6 5.6 103.2 65.8 na 265.6 Benefitfocus, Inc. (BNFT)** $256.6 $293.2 10.0% 14.3% 53.2% 54.9% 0.6% 3.7% $1,099 4.3 3.7 68.7 40.6 na 420.6 Alteryx, Inc. (AYX) $125.5 $170.6 46.3% 35.9% 83.7% 84.4% -14.7% -11.7% $1,035 8.2 6.1 na na na na CommerceHub (CHUBA)** $113.2 $129.9 12.6% 14.8% 79.8% 80.1% 32.9% 35.2% $1,014 9.0 7.8 22.5 19.2 47.0 38.9 Instructure, Inc. (INST)** $153.7 $200.0 38.6% 30.1% 72.2% 73.4% -25.0% -12.9% $939 6.1 4.7 na na na na SPS Commerce, Inc. (SPSC)** $219.3 $251.1 13.5% 14.5% 67.8% 68.3% 11.2% 12.1% $827 3.8 3.3 25.8 21.0 66.7 54.0 LivePerson Inc. (LPSN) $215.2 $230.2 -3.4% 7.0% 74.2% 75.0% 3.5% 3.3% $701 3.3 3.0 34.9 28.4 150.6 90.3 Everbridge, Inc. (EVBG) $102.5 $129.1 33.4% 26.0% 71.6% 71.8% -7.8% -5.3% $692 6.7 5.4 na 461.0 na na Castlight Health, Inc. (CSLT)** $132.9 $169.6 30.7% 27.6% 68.4% 70.5% -24.0% -9.5% $465 3.5 2.7 na na na na ChannelAdvisor Corp. (ECOM)** $124.1 $138.1 9.6% 11.3% 77.8% 77.6% -0.3% 0.9% $247 2.0 1.8 38.5 25.7 na 143.8 MiX Telematics Limited (MIXT)** $123.8 $134.3 6.8% 8.5% 67.7% 68.2% 14.9% 17.2% $205 1.7 1.5 7.1 5.8 17.7 13.8 Group Average: 26.0% 22.2% 73.4% 74.0% 5.5% 8.4% 7.0 5.6 75.9 55.8 83.5 99.9 Group Median: 29.9% 23.2% 74.2% 74.8% 6.9% 9.6% 6.8 5.6 40.8 31.7 66.7 58.4 Maximum: 49.3% 37.3% 83.8% 84.4% 32.9% 35.2% 11.9 9.9 281.3 461.0 245.6 420.6 Minimum: -3.4% 7.0% 53.2% 54.9% -25.0% -12.9% 1.7 1.5 7.1 5.8 17.7 13.8 (800) 866-3272 10 First Analysis Securities Corporation SaaS Quarterly Insights October 2, 2017 SaaS Company Quarter Performance (Source: First Analysis) YTD QTR ** = Currently covered by FA 3/31/14 Price 12/30/16 Price 06/30/17 Price 09/29/17 Price Change Change Human Capital BlackLine Inc. (BL) $27.63 $35.74 $34.12 23.5% -4.5% Callidus Software Inc. (CALD) 12.52 $16.80 $24.20 $24.65 46.7% 1.9% Cornerstone OnDemand Inc. (CSOD)** 47.87 $42.31 $35.75 $40.61 -4.0% 13.6% Coupa Software Inc. (COUP)** $25.01 $28.98 $31.15 24.6% 7.5% Instructure, Inc. (INST)** $19.60 $29.55 $33.15 69.1% 12.2% Paycom Software, Inc. (PAYC)** 15.35 $45.49 $68.39 $74.96 64.8% 9.6% Paylocity Holding Corp. (PCTY)** 24.05 $30.01 $45.18 $48.82 62.7% 8.1% 2U, Inc. (TWOU)** 13.65 $30.15 $46.92 $56.04 85.9% 19.4% The Ultimate Software Group, Inc. (ULTI) 137 $182.35 $210.06 $189.60 4.0% -9.7% Workday, Inc. (WDAY)** 91.43 $66.10 $97.00 $105.39 59.4% 8.6% Average: 43.7% 6.7% Median: 53.1% 8.4% Healthcare Analytics athenahealth, Inc. (ATHN) ** 160.24 $105.17 $140.55 $124.36 18.2% -11.5% Benefitfocus, Inc. (BNFT)** 46.97 $29.70 $36.35 $33.65 13.3% -7.4% Castlight Health, Inc. (CSLT)** 21.22 $4.97 $4.12 $4.30 -13.5% 4.4% Medidata Solutions, Inc. (MDSO) 54.34 $49.67 $78.20 $78.06 57.2% -0.2% Veeva Systems Inc. (VEEV) 26.7 $40.70 $61.32 $56.41 38.6% -8.0% Average: 22.8% -4.6% Median: 18.2% -7.4% IoT/M2M Alarm.com Holdings, Inc. (ALRM)** $27.83 $37.63 $45.18 62.3% 20.1% MiX Telematics Limited (MIXT)** $6.25 $7.88 $9.92 58.7% 25.9% Average: 60.5% 23.0% Cyber Security Proofpoint, Inc. (PFPT)** 37.08 $70.65 $86.83 $87.22 23.5% 0.4% Qualys, Inc. (QLYS)** 25.43 $31.65 $40.80 $51.80 63.7% 27.0% Average: 43.6% 13.7% E-Commerce Optimization ChannelAdvisor Corp. (ECOM)** $14.30 $11.50 $11.50 -19.6% 0.0% CommerceHub (CHUBA)** $15.01 $17.42 $22.57 50.4% 29.6% Five9 Inc. (FIVN) $14.19 $21.52 $23.90 68.4% 11.1% HubSpot (HUBS) $46.90 $65.75 $84.05 79.2% 27.8% LivePerson Inc. (LPSN) 12.07 $7.55 $11.00 $13.55 79.5% 23.2% RingCentral, Inc. (RNG) $20.60 $36.58 $41.75 102.7% 14.1% Salesforce.com, Inc. (CRM) 57.09 $68.47 $86.57 $93.42 36.4% 7.9% SPS Commerce, Inc. (SPSC)** 61.45 $69.89 $63.76 $56.71 -18.9% -11.1% Zendesk, Inc. (ZEN) $21.20 $27.78 $29.11 37.3% 4.8% Average: 46.2% 11.9% Median: 50.4% 11.1% Other SaaS Alteryx, Inc. (AYX) $15.55 $19.60 $20.37 31.0% 3.9% Atlassian Corporation PLC (TEAM) $24.08 $35.28 $35.15 46.0% -0.4% Everbridge, Inc. (EVBG) $18.45 $24.43 $26.42 43.2% 8.1% LogMeIn, Inc. (LOGM) 44.89 $96.55 $104.95 $110.05 14.0% 4.9% MuleSoft, Inc. (MULE) $24.75 $25.04 $20.14 -18.6% -19.6% New Relic, Inc. (NEWR)** $28.24 $43.19 $49.80 76.3% 15.3% ServiceNow, Inc. (NOW) 59.92 $74.33 $106.51 $117.53 58.1% 10.3% Average: 35.7% 3.2% Median: 43.2% 4.9% Overall SaaS Group Average: 40.7% 7.1% Median: 46.0% 7.9% S&P 500 Index 2,238.83 2,423.41 2,519.36 12.5% 4.0% (800) 866-3272 11 First Analysis Securities Corporation SaaS Quarterly Insights October 2, 2017 Human Capital Technology Analysts: Corey Greendale, James Macdonald, Ken Wang Companies: BL, CALD, COUP, CSOD, INST, PAYC, PCTY, TWOU, ULTI, WDAY Profitability becoming more important in HCT universe Similar to our broader SaaS universe, we find the Rule of 40 (R40) serves as a better predictive indicator of valuation than revenue growth for our human capi- tal technology (HCT) group. The R40 correlation is 0.63 using 2017 data, which compares to a correlation of 0.54 for revenue growth (also using 2017 data). Investors remain primarily focused on rewarding companies leveraging large market opportunities to power rapid top-line growth, with this focus on growth historically creating less of an emphasis on near-term profitability. However, evaluating the difference between the R40 and revenue growth correlations leads us to believe that for our HCT group profitability is becoming a more meaningful investor consideration. In the long term, as our current HCT universe constitu- ents evolve into mature companies while successfully capturing greater share in their respective markets, we expect investor emphasis to continue to shift toward EBITDA and bottom-line profitability as well as free cash flow growth. Within our HCT universe, four companies, Paycom, Ultimate Software, Paylocity, and Workday, meet the R40 criteria, and we will refer to these four companies as "the R40 group." We note that the R40 group’s average 2017 estimated revenue is $936 million compared to $249 million for the non-R40 names (we believe the R40 group’s larger revenue base reflects, among other factors, its average con- stituent age of 20 years compared to 12 years for the non-R40 group and the fact that they have particularly large addressable markets). The R40 group’s average estimated adjusted EBITDA margin for 2017 is 22% compared to minus-4% for the non-R40 names. Finally, we note that the R40 group’s average estimated 2017 revenue growth is 28%, which is equivalent to the average estimate for the non-R40 group. Accordingly, the disparity in R40 achievement between the two groups can be attributed to the lower average EBITDA margin for the non-R40 group. We believe the R40 group’s higher EBITDA margin largely reflects greater scale efficiencies associated with the larger average revenue base of its four con- stituents (average expected 2017 revenue for the R40 group is nearly four times the size of the non-R40 group’s average figure). As noted, the average revenue growth expectations are equivalent for both groups, despite the R40 group growing from a significantly larger revenue base. We believe this dynamic may reflect the market orientation of the R40 group, with its constituents targeting well established markets (such as the payroll market for Paycom, Paylocity, and Ultimate Software and the human capital manage- ment market for Workday) where growth is driven largely by taking share from entrenched competitors with less-robust technology capabilities and often high margins. While we believe the non-R40 companies target large and growing mar- kets from a long-term perspective, we view many of their markets as remaining at a relatively early stage (such as the cloud procure-to-pay market targeted by Coupa), where a higher percent of sales are greenfield. Given the earlier stage of these markets and the companies’ high margin potential with scale, we believe it makes sense for them to invest heavily in R&D and sales & marketing and oper- (800) 866-3272 12 First Analysis Securities Corporation SaaS Quarterly Insights October 2, 2017 ate at low or negative margin at present in order to grow their footprint, which we believe generally has the potential to be substantial. Paylocity and 2U are compelling From a valuation standpoint, we see Paylocity and 2U as the two most compel- ling constituents within our HCT universe. Paylocity, whose EV/revenue multiple is 6.5x consensus FY2018e revenue, targets the large and established payroll and talent management (TM) markets, which we expect to allow the company to maintain annual revenue growth above 25% for the foreseeable future while progressing toward the 25-30%+ EBITDA margin profile achieved by payroll/TM peer Paycom (we model 29% EBITDA margin for Paycom in CY2017 and 30% in CY2018, and 19.5% in CY2017 and 19.7% in CY2018 for Paylocity), suggest- ing sustained R40 achievement over at least the next several years. We expect Paylocity’s EV/revenue valuation multiple to expand to reflect its R40 achieve- ment and view its current 6.5x 2018e EV/revenue multiple as compelling relative to Paycom’s 8.2x comparable EV multiple of consensus 2018 revenue. While 2U is not expected to meet R40 criteria in 2017 on an organic basis (the R40 in Table 2 largely reflects inorganic growth), our model calls for it to come close in 2018, with 34.4% organic revenue growth and 4.8% adjusted EBITDA margin. We note 2U does reach 40% for both 2017 and 2018 under the First Analysis Rule of 40 criteria. Further, we expect it to sustain 30%+ organic reve- nue growth for the foreseeable future and 30%+ EBITDA margin at maturity, with a model that should allow it to reach R40 in the long run. We view 2U’s current valuation, at 6.5x 2018e revenue, as compelling given 2U’s leadership position in the large and expanding online program management (OPM) market. We believe this will allow 2U to achieve or exceed its targets of 30%+ annual revenue growth for the foreseeable future as well as expand EBITDA margin toward its long-term target level in the mid-30s range. (800) 866-3272 13 First Analysis Securities Corporation SaaS Quarterly Insights October 2, 2017 Healthcare Analytics Analyst: Frank Sparacino Companies: ATHN, BNFT, CSLT, MDSO, VEEV Three healthcare names in bottom half of R40 rankings Three of our five healthcare names, athenahealth, Benefitfocus, and Castlight Health, are in the bottom half of the R40 rankings. Interestingly, despite signifi- cantly different R40 scores, the 2017 valuation (EV/sales) multiples show less of a differential: for example, ATHN’s 2017 R40 score of 34.6% and EV/sales multiple of 4.2X; BNFT’s 2017 R40 score of 16.2% and 2017 EV/sales multiple of 3.9X; and CSLT’s R40 score of 6.3% and 2017 EV/sales multiple of 3.4X. Absent activist (Elliott Associates) interest first disclosed in May 2017 that drove ATHN’s shares more than 20% higher in a single day, ATHN’s valuation would most likely be in line with BNFT and CSLT despite generating more than 20% EBITDA margins vs. continued losses at CSLT and modest profitability at BNFT. We think this speaks to a number of factors including 1) a challenging healthcare provider environment (both hospitals and physician groups) that is clouded by repeated attacks on the ACA and growth in consumerism, namely the growth in high-deductible health plans and increasing financial exposure for Americans leading to different utilization choices and 2) a substantially more optimistic outlook across the health benefits technology landscape (cloud-based benefits administration, wellness incentive platforms, and benefits navigation/integration hub) where CSLT and BNFT operate. (800) 866-3272 14 First Analysis Securities Corporation SaaS Quarterly Insights October 2, 2017 Internet of Things / M2M Analysts: Howard Smith, David Gearhart Companies: ALRM, MIXT Smart Home: Not concerned with projected drop in ALRM's R40 Alarm.com’s R40 metric has been solid for multiple years, consistently coming in above 40% and composed of a relatively balanced mix of top-line growth and profitability. However, excluding the revenue from Connect and Piper (acquired from Icontrol in March 2017), Alarm.com’s R40 is anticipated to fall to 34.2% in 2017 and be about flat in 2018 (at 35.0%; see Table 2). The decline in the metric is from slowing organic growth expectations, primarily in the non-strategic hard- ware line (~30% of total revenue). We are not concerned with this anticipated decline as a result, and we believe there is a high likelihood revenue growth will exceed expectations driven by the core SaaS & License revenue line, helping the R40 remain at levels similar to the recent past; we model 19.5% organic recurring revenue growth in 2017 and roughly 17% in 2018. Our confidence stems from Alarm.com’s tendency to exceed the high end of guidance for SaaS & License revenue, noting it has accomplished this for eight consecutive quarters. In ad- dition, consensus estimates align with the guidance set by management, which assumes the enabling hardware business grows at modest levels (estimated organic growth of ~2.5% in 2017) despite being up 20-30% in each of the last two years, making us feel revenue guidance is conservative. Our Smart Home interactive security survey (published Sept. 6) gives us added confidence, with the large service providers (dealers) seeing mid-teens subscrib- er growth the prior year and expecting this to continue. In addition, it appears Alarm.com could grow faster than this level by adding more service providers and becoming the primary vendor, which our survey suggests it is having good suc- cess doing at the expense of its rivals. Alarm.com also has a number of growth initiatives outside North America home security, any of which could function as a catalyst near term and help growth exceed expectations, including international expansion, commercial security, the HVAC channel, and add-on modules. Looking at profitability, adjusted EBITDA margin is expected to rise mainly due to the higher-margin Icontrol assets being incorporated into the model. In our longer-term model, we have adjusted EBITDA margin rising to 33.5% by the end of our five-year horizon from 2016's 18.4%, driven by the greater mix of higher- margin (80-85%) SaaS revenue relative to hardware and the company leveraging operating expenses. This, combined with Alarm.com capitalizing on its position to drive strong revenue growth as the broader Smart Home opportunity emerges, makes us believe the company will consistently have an R40 above 40%, which should portend strong share performance. Fleet Telematics: MIX's R40 should continue to improve MiX Telematics, on first glance, has a fairly pedestrian R40 metric for FY18 of 30.3% that falls in the bottom half of the overall SaaS group (see Table 2). How- ever, this number represents a strong improvement over FY17's 24.7%, and its R40 is projected to rise again in FY19 to 34.7%. The recent improvement stems from a diminishing of the macro headwinds (oil prices, South Africa) and other issues that plagued MiX over the past few years as well as the company being further along in its ongoing business model shift (enabling hardware bundled into the monthly subscription vs. being sold upfront), allowing management’s consis- (800) 866-3272 15 First Analysis Securities Corporation SaaS Quarterly Insights October 2, 2017 tently solid execution to show in the form of increasingly better metrics – which underlies our investment thesis and has resulted in strong year-to-date share performance (+58.7%). Earlier this year, management indicated MiX had reached an inflection point in terms of profitability, with adjusted EBITDA margin set to steadily expand to the 30%+ level due to a handful of catalysts. These include a better top-line trajectory to leverage, the company exiting its multi-year investment cycle (which funded its new software platform), tight management of S&M (taking it down to 11-12% of revenue from the current 12-13%), continued sales of high-margin add-on mod- ules and penetration of fully bundled plans, and international operations starting to reach scale. We think each of these items is credible, and combined they give us confidence in MiX achieving its long-term (five-year) profitability targets. In terms of top-line growth, we believe high-single-digit to 10%+ growth is rea- sonable, considering the diminished headwinds noted above and a lessening impact from the model shift to fully bundled plans as well as international expan- sion and the sale of add-ons. This level of revenue growth and adjusted EBITDA margin would place MiX around 40% for its R40 metric, which should translate into a much healthier valuation multiple than its 1.7X and 7.1X 2017e revenue and adjusted EBITDA, respectively, noting MiX remains dramatically below the overall SaaS group’s 7.0X and 75.9X. (800) 866-3272 16 First Analysis Securities Corporation SaaS Quarterly Insights October 2, 2017 Cyber Security Analysts: Howard Smith, David Vercoutere Companies: PFPT, QLYS Security: rich valuations reflect sound R40 profiles The rich valuation levels of Proofpoint, at an EV 9.5X 2017 revenue, and Qualys, at 7.4X 2017e revenue, reflect their strong 2017 R40 profiles of 47% and 48%, respectively. In addition, per current consensus estimates, their R40 measures are expected to remain at healthy levels in 2018 at 43% and 50%, respectively. We note Proofpoint has a meaningfully higher valuation on an EV-to-revenue ba- sis (on both 2017 and 2018 consensus revenue estimates) compared to Qualys despite its lower R40 figure in both 2017 and 2018. Since reporting Q2 earnings in early August, Qualys' stock has risen 26%, lifting its EV/2017e revenue to above 7X from about 5.5X earlier in the year on decent reported performance and healthy business metrics that indicate potential for better momentum. Despite the increase in Qualys' valuation over the past couple months, we believe Proofpoint’s valuation remains materially ahead of Qualys' due to Proofpoint’s substantially faster revenue growth rate. Our regression analysis (with revenue growth and EBITDA the independent variables) suggests the growth rate accounts for about two-thirds of the valuation, with Proofpoint’s expected growth rates in 2017 and 2018 representing more than double the fraction in the R40 sum compared to Qualys. In addition, we think the quality of Proofpoint’s growth profile is more robust. The company has consistently dem- onstrated its ability to exceed expectations driven largely by its excellent overall execution, making it relatively more likely Proofpoint will be able grow into its valuation. Given Proofpoint’s disciplined cost culture, this continued fast growth should give it room for greater leverage and expand its profitability, which would boost its R40 numbers. Hence, we think Proofpoint’s R40 numbers have solid potential to turn out higher on both growth and profit upside. We believe these dynamics warrant the richer valuation levels compared to Qualys, despite the comparatively less-favorable R40 profile. We see lesser growth upside for Qualys in 2017, though more in 2018 given the product expansion of its cloud platform and ongoing go-to-market optimization in engaging more strategically with enterprises. Combined with strong EBITDA margins (it is one of only four companies in our SaaS universe with 30%-plus EBITDA margin), we expect it will be relatively tougher for Qualys to expand its R40 profile beyond current levels, but we note the company already boasts strong R40 numbers. Important disclosures and certifications begin on page XX of this report Analyst: Craig Nankervis E-mail: cnankervis@firstanalysis.com Phone: 312-258-7129 Companies discussed in this report Public Companies Ticker Price IBM Corp. IBM $194.49 Intel Corp. INTC $21.46 Private Companies AlertLogic nCircle Tenable Network Security Rapid7 RedSeal Networks Risk I/O Veracode Whitehat Security Table of Contents: VM Functionality Scheme 2 Deployment models 3 A look at the VM ecosystem 4 VM challenges 5 Some VM trends 5 Some ecosystem players to watch 6 Qualys Inc. Basic Report 9 Network Security Initiate coverage Company Ticker Price Rating Qualys Inc. QLYS $14.89 overweight Network Security October 23, 2012 Craig Nankervis · cnankervis@firstanalysis.com Initiating Coverage: Company Ticker Rating Market Cap Price Qualys Inc. QLYS overweight $527.1MM $14.89 Vulnerability management: Tablestakes for improving risk posture ■ We map the landscape, discuss some challenges and trends, and sketch a few private players. ■ We see Qualys's distinguishing SaaS approach gaining increasing appeal, and as likely the preferred enterprise VM solution architecture in coming years (p. 9). Vulnerabilities are security holes in software, hardware, or operating systems that provide an opening or means to potentially attack a system. Brodly speaking, vulneraility managemnt (VM) centers on understanding what holes exist in an IT infrastructure and effectively addressing them before they're exploited by attack- ers. It is automated security and compliance audit capability that evaluates and reports on IT-asset risk given 1) the most rcent changes to a network and 2) the latest known attack threats. Below, we offer an industry overview as a lead-in to our Qualys discussion. We paint the VM landscape, map VM’s role in the broader security/compliance ecosystem, discuss some challenges nd trends, and sketch a few interesting private plyers Scanning for security holes: Testing anything with an IP address Principal VM functions are 1) scanning or testing IT assets for known security holes and 2) work flow for post-scan reporting and remediation management. External-facing, perimeter assets that are typically scanned for the latet attack vlnerabilities include organization Web sites and partner/trading networks. Internal assets are more profuse, and scanning encompasses most anything connected to a network: desktops, mail servers, databases, switches, routers, applications, perating systems, wireless access points, firewalls, and more. Important disclosures and certifications begin on page 34 of this report (800) 866-3272 17 First Analysis Securities Corporation SaaS Quarterly Insights October 2, 2017 e-Commerce Optimization Analysts: David Gearhart, Lawrence Berlin Companies: CHUBA, CRM, ECOM, FIVN, HUBS, LPSN, RNG, SPSC, ZEN High R40 for CHUBA should continue CommerceHub’s 2017 R40 metric is anticipated to be 52.4%, which ranks it among the top companies in the overall SaaS group (see Table 2) and helps ex- plain its current valuation multiples; we note it had the same R40 in 2016. Its R40 is expected to rise to 55.4% in 2018, driven by an improvement in top-line growth as the drag from Mercent falls off exiting 2017, ending the purposeful shedding of its undesired managed services accounts, and better comps. We think Commer- ceHub should be able to keep its R40 at or even above this level due to con- sistent revenue growth and strong-to-improving profitability such that one could reasonably argue the stock should hold its current valuation multiples. Looking at growth first, we note North American online retail sales are growing at roughly 15% annually (11% excluding Amazon) and should continue to expand at similar rates for a while from the ongoing shift of product demand to the online environment away from traditional brick & mortar stores, with consumers drawn to the broader product selections, more competitive pricing, and convenience af- forded them online. CommerceHub is benefiting from this trend, which provides it with solid underlying growth considering the company’s transaction-based model. The company is also driving revenue expansion from a handful of vectors, includ- ing the addition of new retailer/supplier (brand) customers, growing penetration of drop ship within existing accounts, connection growth within its network, and the sale of add-on functionality; it is in the early stages of international expan- sion, which should be additive over time as well. These items in aggregate give us confidence in CommerceHub producing total revenue growth at least in line with the market’s growth rate (~15%). We expect its usage-based (transaction) revenue (70% of the total) to grow faster than the market given the above drivers while its subscription and professional services grow slower. In terms of profitability, CommerceHub is nearing 40% annual adjusted EBITDA margins (37.6% in 2016) stemming from its high gross margins (77.7% in 2016) and low-cost customer acquisition model targeting large retailers, which results in suppliers being brought on as paying customers at negligible incremental cost. Its adjusted EBITDA margin should rise over time (we model 40.6% and 40.9% in 2017 and 2018, respectively) as gross margin benefits from the lower-margin managed services revenue from Mercent being out of the mix in 2018 and be- yond as well as CommerceHub seeing operating leverage, specifically from R&D and G&A. Putting the above growth trajectory and profitability profile together, we believe we have a recipe for consistently high R40 metrics. ECOM's R40 ranked low but growth acceleration expected ChannelAdvisor is near the bottom of the SaaS companies in our Rule of 40 rankings. However, we have confidence in its growth acceleration as well as its ability to expand its EBITDA margin in 2017 and beyond. In 2016 and 2017, ChannelAdvisor altered its client mix, shedding many smaller, unprofitable (or (800) 866-3272 18 First Analysis Securities Corporation SaaS Quarterly Insights October 2, 2017 barely profitable) clients and retooling its product and sales team to work with larger clients. As a result, its number of core clients remained in the 2,900 range. However, its average trailing-12-month revenue per core customer has begun to step up, going from $35,753 in Q1 2016 to $41,029 in Q2 2017. We believe a rise in the number of clients and in revenue per client will increase growth into the mid-teens in the next couple of years. We believe the added growth will help EBITDA margin since there is only a low variable cost tied to each marginal revenue dollar. As a result, we believe its Rule of 40 number should improve, although we think approaching 40% could take many years and will be highly dependent on improved margins. Expect SPSC's R40 to remain uninspiring near term SPS Commerce’s R40 metric has been on a downward trajectory, going from 38.1% in 2015 to 35.5% in 2016 and is anticipated to fall even further in 2017 (to 28.1%; see Table 2) before rebounding modestly in 2018 to 30.2%. As one would expect, its recent share performance has also been down (by 8.8% year-to-date). The change in its R40 primarily stems from slowing top-line growth, with recurring revenue (92% of total revenue) decelerating to the mid-teens from the low-to-mid 20s levels due to weaker net customer additions. Earlier this year, management pulled its expectation for recurring revenue growth to return to the 20% level sometime in 2018 because of this and despite SPSC’s consistently gaining wallet share with its existing customers. It cited light community enablement program activity from retailers as the cause, with these companies spending more time working through their e-commerce strategies instead; these programs facilitate the on-boarding of their suppliers to SPSC’s platform, making each supplier a paying SPSC customer. We note it is possible for SPSC’s recurring revenue growth to accelerate in the short to medium term, with the company potentially benefiting from changes made to its sales organization in 2016 and the release of its new platform that could hasten sales velocity. But we believe the company needs reinvigorated community enablement program activity to drive a rebound in net additions, thereby fostering much greater growth – something we don’t have sufficient visibility/data points to handicap at this time. This leaves it to improving profitability to reverse the course of the R40 metric. However, manage- ment’s policy is to reinvest profits in excess of target levels back into the busi- ness, which makes us believe profitability is unlikely to increase materially near term unless management philosophy changes. In addition, we feel that should management dial back the excess investments to improve profitability, it could have a negative impact on near- and/or longer-term revenue growth, potentially keeping the R40 unchanged or worse. We see the above uncertainty around top-line growth and profitability dynamics as implying an uninspiring R40 metric at least near term, equating to what we think will be relatively flat share perfor- mance. (800) 866-3272 19 First Analysis Securities Corporation SaaS Quarterly Insights October 2, 2017 Other SaaS Analysts: David Vercoutere Companies: NEWR Investments hold back NEWR's R40 performance in near term As with other SaaS names, revenue growth is the primary reason for New Relic's rich valuation/high EV-to-revenue multiple. However, despite a strong 30%-plus growth profile, New Relic isn't expected to reach a 40% R40 level in 2017 or 2018 due to its still-modest EBITDA. We think New Relic’s ongoing transition to capture greater market/wallet share in the enterprise market helps explain the R40 underperformance. While we hope 30%-plus revenue growth will be sustained and the company achieves better-than-expected enterprise traction, its more modest profitability profile is understandable given its investments, primarily in sales and marketing, to capitalize on the still-early enterprise opportunity. We feel New Relic has ample opportunity to show better leverage once the enterprise business finds greater maturity due to a more productive sales motion, which combined with its growth opportunity should raise the company’s R40 numbers closer to or above 40% over the mid term. Applying our proprietary First Analysis Rule of 40 framework, New Relic exceeds the 40% threshold in both 2017 and 2018. This is understandable since our rule puts a premium on revenue growth as the most important variable for valuation levels, explaining NEWR's rich valuation despite falling short on the traditional R40 measure. (800) 866-3272 20 First Analysis Securities Corporation SaaS Quarterly Insights October 2, 2017 IMPORTANT DISCLOSURES AND CERTIFICATIONS ANALYST CERTIFICATION: We, Howard Smith, David Gearhart, Ken Wang, Corey Greendale, Frank Sparacino, Lawrence Berlin, James Macdonald and David Vercoutere, attest the views expressed in this document accurately reflect our collective personal views about the subject securities and issuers. We further attest no part of our compensation was, is, or will be, directly or indirectly, related to the specific recommendations or views expressed by us herein. SPECIFIC DISCLOSURES: 2U Inc.: FASC expects to receive or intends to seek compensation for investment banking services from this company within the three months following the publication date of this document. FASC has received compensation for investment banking services from this company within the 12 months before the publication date of this document, and this company was thus a client of FASC for investment banking services at that time. FASC managed or co-managed a public offering of securities for this company within 12 months before the publication date of this document, and this company was thus a client of FASC for investment banking services at that time. Alarm.com Holdings Inc.: None. athenahealth Inc. : None. Atlassian Corp.: None. Benefitfocus Inc.: None. BlackLine Inc.: None. Callidus Software Inc.: None. Castlight Health Inc.: None. ChannelAdvisor Corp.: None. CommerceHub Inc.: None. Cornerstone OnDemand Inc.: None. Coupa Software: None. HubSpot Inc. : None. Instructure Inc. : None. LivePerson Inc.: None. MiX Telematics Ltd.: David Gearhart has a long position in the common stock of this company. New Relic Inc.: None. Paycom Software Inc.: None. Paylocity Holding Corp.: None. Proofpoint Inc.: None. Qualys Inc.: None. RingCentral Inc.: None. salesforce.com inc.: None. SPS Commerce Inc.: None. Ultimate Software Group Inc.: None. Veeva Systems Inc.: None. Workday Inc.: None. OTHER DISCLOSURES: The compensation of the research analyst(s) principally responsible for the preparation of this document is indirectly based on (among other factors) the general investment banking revenue of FASC. FASC considers all the companies covered in its research reports to be potential clients. Price, rating, and target price history for all covered companies can be accessed at www.firstanalysis.com/coverage. You can also call 1-800-866-3272 or write: First Analysis Securities Corp., One South Wacker Drive, Suite 3900, Chicago, IL 60606. RATINGS DEFINITIONS*: Overweight (O): Purchase shares to establish an overweighted position: Stock price expected to perform better than the S&P 500 over the next 12 months. Equal-weight (E): Hold shares to maintain an equal-weighted position: Stock price expected to perform in line with SaaS Quarterly October 2, 2017 (800) 866-3272 2 First Analysis Securities Corporation (800) 866-3272 21 First Analysis Securities Corporation SaaS Quarterly Insights October 2, 2017 the S&P 500 over the next 12 months. Underweight (U): Sell shares to establish an underweighted position: Stock price expected to perform worse than the S&P 500 over the next 12 months. *Stock target prices may at times be inconsistent with these definitions due to short-term stock price volatility that may not reflect large-holder/buyer valuations of the security. DISTRIBUTION OF RATINGS: The following was the distribution of ratings for companies rated by FASC as of 6/30/2017: 44% had buy (overweight) ratings, 52% had hold/neutral (equal-weight) ratings, and 4% had sell (underweight) ratings. Also as of 6/30/2017, FASC had provided, within the prior 12 months, investment banking services to 9% of the companies rated that had buy (overweight) ratings, 0% of the companies rated that had hold (equal-weight) ratings, and 0% of the companies rated that had sell (underweight) ratings. For purposes of the FINRA ratings distribution disclosure requirements, our stock ratings of overweight, equal-weight, and underweight most closely correspond to buy, hold, and sell, respectively. Please refer to "RATINGS DEFINITIONS" above for an explanation of the FASC rating system. USE OF THIS DOCUMENT: Investors should consider this document as only a single factor in making their investment decision. Past performance and any projections herein should not be taken as an indication or guarantee of future performance. With the exception of information about FASC, the information contained herein was obtained from sources we believe reliable, but we do not guarantee its accuracy. As a subscriber or prospective subscriber, you have agreed not to provide this document in any form to any person other than employees of your immediate organization. FASC is a broker-dealer registered with FINRA and member SIPC. It provides research to its institutional clients as a service in connection with its other business activities. This document is provided for informational purposes only. Neither the information nor any opinion expressed constitutes a solicitation by us of the purchase or sale of any securities. More information is available on request from FASC 800-866-3272. Copyright 2017 First Analysis Securities Corp. To residents of Canada: The contents hereof are intended solely for the use of, and may be only be issued or passed on to, persons to whom FASC is entitled to distribute this document under applicable Canadian securities laws. To residents of the United Kingdom: This document, which does not constitute an offer of, or an invitation by or on behalf of any person to subscribe for or purchase, any shares or other securities in any of the companies mentioned in this document, is for distribution in the UK only to persons who fall within any one or more of the categories of persons referred to in Article 8 of the Financial Services Act 1986 (Investment Advertisements) (Exemptions) (No. 2) Order 1995 (SI 1995/1536) or in Article 11 of the Financial Services Act 1986 (Investment Advertisements) (Exemptions) Order 1996 (SI 1996/1586). ABBREVIATIONS AND ACRONYMS: The meaning of the following abbreviations and acronyms has been identified as not common knowledge, and we therefore provide these explanations. DCF: Discounted cash flow (model). DSOs: Days sales outstanding. EBITDA: Earnings before interest, taxes, depreciation, and amortization. EV: Enterprise value. G&A: General and administrative (expense). OEM: Original equipment manufacturer. R&D: Research and development (expense). SG&A: Selling, general, and administrative (expense). If you want to be removed from our distribution list entirely, please e-mail to optout@firstanalysis.com. If you want to modify your preferences for which e-mails you receive, please e-mail djs@firstanalysis.com. SaaS Quarterly October 2, 2017 (800) 866-3272 3 First Analysis Securities Corporation Online Research: www.research-driven.com Research: (800) 866-3272 • Trading: (800) 322-3272 • (312) 258-0660 One South Wacker Drive • Suite 3900 • Chicago, IL 60606 First Analysis Securities Equity Research Technology / SaaS Healthcare Environmental technology Services e-Commerce optimization Revenue optimization Lawrence Berlin lberlin@firstanalysis.com Financial technology Lawrence Berlin lberlin@firstanalysis.com Process optimization David Gearhart dgearhart@firstanalysis.com Cyber security/infrastructure Howard Smith hsmith@firstanalysis.com David Vercoutere dvercoutere@firstanalysis.com Human capital technology Corey Greendale cgreendale@firstanalysis.com James Macdonald jmacdonald@firstanalysis.com Ken Wang kwang@firstanalysis.com Internet of things Howard Smith hsmith@firstanalysis.com David Gearhart, CFA dgearhart@firstanalysis.com Medical technology Tracy Marshbanks, Ph.D. tmarshbanks@firstanalysis.com Joseph Munda jmunda@firstanalysis.com Pharma technology Steven Schwartz sschwartz@firstanalysis.com Tracy Marshbanks, Ph.D. tmarshbanks@firstanalysis.com Healthcare analytics Frank Sparacino, CFA fsparacino@firstanalysis.com General analytics Frank Sparacino, CFA fsparacino@firstanalysis.com Resource management Corey Greendale cgreendale@firstanalysis.com Ken Wang kwang@firstanalysis.com Clean-tech / specialty chemicals Steven Schwartz, CFA sschwartz@firstanalysis.com Tracy Marshbanks, Ph.D. tmarshbanks@firstanalysis.com Education Corey Greendale cgreendale@firstanalysis.com Ken Wang kwang@firstanalysis.com Payroll and benefits James Macdonald jmacdonald@firstanalysis.com Accounts receivable management Lawrence Berlin lberlin@firstanalysis.com
