Image: Ultimate Software.
Managing a workforce is one of the most complex tasks that any company has to accomplish, and the rise of technology has brought with it a number of ways to make human-resources management easier. Huge companies like Automatic Data Processing (NASDAQ: ADP) offer to take over HR functions entirely, but Ultimate Software Group (NASDAQ: ULTI) offers its clients the power of cloud computing to help them deal with HR more efficiently themselves. The stock has inexorably advanced to new all-time record highs recently as more investors see the potential from the business.
Coming into Tuesday afternoon's third-quarter financial report, Ultimate Software investors were looking for the company to continue its impressive track record of growth. The company not only largely delivered this quarter, but sees even more-favorable conditions looking ahead. Let's look more closely at Ultimate Software, and why it's more optimistic than ever about its future.
Ultimate Software keeps gaining altitude
Ultimate Software's third-quarter results were consistent with the pace of growth that the tech company has managed for several quarters. Total revenue rose 22%, to $155.3 million, which was less than a percentage point below what most investors had expected to see from the company. GAAP net income fell substantially year over year, but the year-ago figure included one-time tax benefits that distorted the comparison. On an adjusted basis, non-GAAP net income jumped 39%, to $20.5 million, and that produced adjusted earnings of $0.69 per share, topping the consensus estimate by $0.06.
Once again, Ultimate Software succeeded in growing its recurring revenue at a faster pace than its overall business, sporting 23% overall growth. Services revenue rose at a slower rate of 17.5%, and its share of Ultimate's total sales is at 15% and falling steadily as the company has given far more attention to the high-margin opportunities that recurring revenue sources provide.
Repeatedly, though, Ultimate Software has had to deal with keeping its overall costs contained, and the company struggled with that challenge again in the third quarter. Sales and market costs jumped by nearly half from year-ago levels, and general and administrative expenses climbed by 57%. As we've seen in past quarters, though, much of the increase came from big gains in stock-based compensation, which the company excludes from its adjusted results. As long as Ultimate's stock continues to soar, the costs associated with its share-based incentives will soar with it.
CEO Scott Scherr was pleased at the progress that Ultimate continues to make, noting that, "we performed according to plan in this year's third quarter for both our recurring revenues and total revenues, keeping us on target to achieve our 2015 objectives." In addition, Scherr noted that Ultimate got a key certification from a government program that will allow it to file required documents under the Affordable Care Act with the IRS, further enhancing its value proposition to clients.
Why Ultimate Software could have an even better 2016
Ultimate gave investors even better news about its future, giving financial guidance that suggests an acceleration in the pace of its growth next year. The tech company now expects that total revenue will climb by 23% in 2016, faster than the current guidance for 22% growth for the full 2015 year. Recurring revenue will continue to represent an increasingly important component of Ultimate's overall results, with expectations for 25% higher revenue from recurring sources in 2016 compared to the 23% guidance for this year. Operating margins should also improve by a percentage point next year, rising to 21%, and showing the extent to which Ultimate Software is aiming at becoming more efficient internally.
One positive sign came from the fact that Ultimate prudently decided to limit its stock buybacks under its current repurchase program. With its stock soaring, the HR cloud specialist doesn't need to bolster its returns through share repurchases, and conserving cash for potential future use makes a lot more sense at this point.
Overall, Ultimate Software has done an excellent job of staying on track in a growing area of the economy, enjoying the same general success as Automatic Data Processing in benefiting from favorable trends toward higher levels of employment, and the greater need from employers for its services. As long as tailwinds keep favoring the company's efforts to grow, Ultimate Software could continue to produce solid performance for long-term investors.
