Last week, I talked to Scott Scherr, the CEO of Ultimate Software (NASDAQ:ULTI), a human-resources software provider. It's no secret that his goal is to turn his company into the next Paychex (NYSE:PAYX), which is a worthy goal -- after all, that company has a market cap of $15 billion, compared to Ultimate's $585 million. In fact, so far, things are tracking very nicely.
In the third-quarter earnings results released last week, revenues increased 30% to $28.8 million. Net income was $1.3 million, or $0.05 per share, which was up from $700,000, or $0.03 per share, in the same period a year ago.
Founded in 1991, Ultimate Software develops Web-based and on-premise software to help companies manage their HR needs, such as payroll, benefits, recruiting, and termination.
As a result, its business model consists of two types of revenues. For the on-premise software solutions, the revenues come from selling licenses, which are upfront fees. There are also ongoing maintenance and service payments. In other words, this is the traditional software business model.
As for the Web-based software, the model is a monthly subscription payment, which is known as the on-demand approach. This is similar to the model used by highly successful software companies like Salesforce.com (NYSE:CRM) and NetSuite. Because the revenue is recurring, there is no lumpiness in quarterly results (that is, unlike a traditional software company, which needs to constantly sell high-priced software each quarter).
As seen with the third quarter, Ultimate Software's business is moving increasingly toward the on-demand approach. In the quarter, recurring revenues increased 27% to $16.5 million, and software license revenues were only $2.9 million.
A big part of Ultimate Software's strategy is to increase the per-employee-per-month ("PEPM") rate. Thus, the company is working to provide add-on products to sell into its growing customer base. These services will come from internal development, as well as acquisitions.
For example, in the third quarter, Ultimate purchased the source code for an online recruitment application from First Advantage. Another deal was the purchase of RTIX, which focuses on employee performance management.
As for guidance, management forecasts a revenue growth rate of 24%-27% in 2007. True, this is certainly strong -- but is it enough to make it the next Paychex? Well, keep in mind that Ultimate Software will likely exceed $100 million in revenues for 2006. This took the company roughly 15 years to accomplish. For Paychex, the same feat took 18 years.
In fact, the $100 million mark is critical. If you look at Paychex, for example, it was an inflection point that led to more growth -- because of economies of scale and more credibility with prospective customers. And, looking at the recent quarterly reports of Ultimate Software, it does look like the company is already benefiting from these factors. But, more importantly, the CEO realizes that success takes a lot of time -- and investment -- but the results can be very beneficial to shareholders over the long term.
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Fool contributor Tom Taulli does not own shares mentioned in this article. He is currently ranked 12 out of 11,654 in Motley Fool CAPS. The Fool has a disclosure policy.
