A Software Play That's Actually Growing

• BySteve Gear, RealMoney Contributor
• On 8:01 am EST, Tuesday November 18, 2008

What would you call a company that has a four-year revenue growth rate of over 25%, just reported third-quarter year-over-year sales growth of 16% and projects 2009 revenue growth to be 22% to 23%? You'd call it a growth story, and this one goes by the name of Ultimate Software.

Ultimate has carved out a niche in the software/Internet sector by providing small and mid-size companies with Web-based turnkey solutions for human resource functions such as employee benefits, recruiting and scheduling. Ultimate helps its customers save money and increase efficiency, and it has reached a "critical mass" of product offerings and can now approach larger customers. The recent 50% price drop of ULTI shares creates an opportunity for investors in this unique franchise.

Ultimate strives to provide end-to-end solutions by building a portfolio of products that can serve any employee resource need from recruiting through retirement. Since 2002, it has focused on what the company refers to as "intersourcing," which is providing Web-based applications that the company develops, hosts and maintains.

This model has proven extremely attractive to both Ultimate and its customers. From the customers' perspective, the "intersource" or Web-hosted model gives them the services they need through low-cost Web delivery. Managers and employees of client companies are provided with Web portals from which they can access reports and services that Ultimate provides. Clients do not need to allocate resources to build and maintain the needed applications.

Ultimate's flagship product is called UltiPro, which serves as a central gateway for various managerial, employee and human resource services and activities. Once the UltiPro portal is installed, the client can choose from a variety of services to add to the portal. These include applications for recruiting, processing new hires, reviewing, training and compensating employees. This is a classic hub-and-spoke model.

Once Ultimate obtains a critical mass of clients and applications, it can increase both sales and the research-and-development effort that drives sales. The more applications the company can deliver, the better and more valuable its service becomes to prospective customers. Ultimate currently has over 1,600 customers from a wide variety of vertical markets. UTIL can now grow through both new client acquisition and additional sell-through from its existing client base.

How successful has Ultimate's business model been? Clients like the "intersource" (hosted) model because it's cheaper to purchase up front and quicker to implement than building or extending additional services from their internal technology infrastructure. The hosted outsource model is also more lucrative in the long term for Ultimate, as the company gets paid for both the software applications and the maintenance along with any other special services that it is asked to provide during the contract. The hosting services generate recurring revenue as long as a contract is maintained.

Once the company acquires customers, they are very loyal: It has a customer retention rate in excess of 95%. During the third quarter of 2008, recurring revenue grew by 21% on a year-over-basis, with hosting services and maintenance fees accounting for most of the growth. Ultimate has given guidance for 2009 of a 22%-23% increase in revenue with a 30% to 31% increase in recurring revenue, as it sees continued strength in the sales channel.

Ultimate has a strong customer base, nearly $1 per share in cash and short-term investments and a compound annual revenue growth rate of more than 25% over the last four years. The company has a stock buyback program in place and bought 155,100 of its own shares during the third quarter of 2008. Several insiders have recently been purchasing the stock in the $13-$15 range.

This may be one of only a few growth stories for 2009. The company has reached an inflection point in its business model and is poised for growth. Double-digit revenue growth coupled with a company buyback and insider interest should make Ultimate a compelling story.

---

Know What You Own: Other companies in the business software industry include Automatic Data Processing, Oracle, Wipro , Fiserv , Cognizant and Lawson Software.

Buzz up!