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TechWeek: Ultimate Software Fighting

A small-cap software company is adding to the on-demand arsenal.
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isn't exactly the Kleenex of the software world, but it's pretty close to being synonymous with "on demand." And even those in the know look at on-demand, a business model that features subscriptions instead of licenses and software that runs on the vendors' -- not the customers' -- hardware, as being closely related to customer-relationship management.


Ultimate Software


, a smallish-cap company that is approaching the $100 million annual sales barrier, is showing that the model may have legs.

Ultimate, which makes a living providing the kind of outsourced payroll services usually associated with companies like



, reported fourth-quarter financials this week, and the results were a lot better than Wall Street had anticipated.

The Weston, Fla., company delivered a profit of $1.8 million, or 7 cents a share, on revenue that increased 21.7% to $25 million. Analysts polled by Thomson First Call were looking for earnings of 5 cents a share on sales of $23.3 million.

Guidance was strong; the company expects to grow revenue by 27% to 30% in 2006, and bookings, called annual recurring revenue by the company, should grow by 20% to 23%. Shares of Ultimate took off on the news late Thursday, and on Friday shares gained $1.45, or 6.8%, to $22.87.

Before the rally, shares were trading at 64 times estimated 2006 earnings and 41 times estimates for 2007. That's rather cheap compared to Salesforce, trading at 164 and 84 times forward earnings, but a lot more expensive than warhorses like Oracle, trading at 16 and 14 times earnings.

It's worth noting that Ultimate gives neither quarterly nor EPS guidance. The reason: "We don't want to be held hostage to fluctuations in those numbers," CEO and founder Scott Scheer said. Instead, he counsels Wall Street to focus on recurring revenue, which he sees as the foundation of his business. Indeed, Ultimate pays its sales reps a premium of 40% for selling on-demand products as opposed to licensed products.

In the fourth quarter, annual recurring revenue increased by 43.5% to $5 million, well over Wall Street's estimates. "What is particularly surprising to us is not that management raised guidance, but that they only waited one quarter after giving preliminary 2006 guidance to do so," said analyst Karen Haus of WR Hambrecht in a note to clients. Her company does not have an investment banking relationship with Ultimate.

License revenue, generally the focus of investors, goes right to the income statement and, of course, affects earnings immediately. Subscription revenue -- 70% of new Ultimate customers choose to pay by the month -- is recognized ratably, and like maintenance revenue it keeps coming in as long as the customer stays loyal. And Scheer, who founded Ultimate in 1990 after a stint at ADP, boasts that 97% of his customers stay with him, "including the very first one."

While Ultimate was wowing Wall Street (Haus' headline read "wow")



on Thursday delivered a not-very-surprising

update to its guidance that reflects the closing of its $5.85 billion acquisition of Siebel Systems. Morning-after reactions ranged from the mildly disappointed to the mildly upbeat.

Analyst Tony Ursillo, of Loomis & Sayles, was in the slightly unhappy camp, saying he hadn't expected the acquisition to be dilutive in the near term (it knocked a penny off EPS guidance), and said Siebel's contribution to the quarter of just $10 million in license revenue "was weak."

Even so, he noted that at today's low valuations "there isn't all that much downside." His company has a small position in Oracle.

Rick Sherlund of Goldman Sachs, on the other hand, said: "The guidance implied a bit better tone of business for Oracle's core business this quarter, which may be a moderate positive for the stock." Sherlund reinstated his in-line/attractive rating.

"Specifically, guidance implied February quarter license revenues from Oracle would be about $1.071 billion to $1.118 billion (this excludes our estimate of $15 million from Siebel), which compares with our earlier estimate of $1.091 billion, so the high end is a bit more optimistic than our estimate," Sherlund wrote. Goldman has an investment banking relationship with Oracle.