Cloud-Hungry Customers Foster Ultimate Software's Growth

By Dan Caplinger Markets Fool.com

The cloud computing revolution has captured the intention of investors throughout the technology industry, and Ultimate Software Group (NASDAQ: ULTI) has chosen to focus on providing cloud-based human resource management applications for a wide range of customers. That has helped foster impressive growth for Ultimate Software, and a strengthening economy has only made it more important for the company's clients to manage their personnel efficiently and effectively.

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Coming into Tuesday's first-quarter financial report, Ultimate Software investors were enthusiastic about the company's growth prospects, and Ultimate did a good job of delivering on most of their expectations. The stock didn't react positively to its earnings release, but fundamental growth prospects appear to be on track for a healthy future. Let's take a closer look at Ultimate Software's results for insight on the cloud company's prospects going forward.

Image source: Ultimate Software.

Ultimate Software keeps on growing

Ultimate Software's first-quarter results were consistent with past performance. Sales were up 22% to $228.5 million, which almost exactly matched the consensus forecast among those following the stock. Adjusted net income didn't manage to keep up the pace, though, rising just 5% to $23 million. Still, adjusted earnings of $0.75 per share were $0.02 better than the flat performance that most investors were expecting to see.

From a fundamental perspective, the favorable momentum that Ultimate Software has sustained appeared to continue unblemished during the quarter. Recurring revenue was up 24% to $190 million, just a single percentage point slower than its pace of growth in the fourth quarter of 2016. Services revenue grew at only half the rate of Ultimate's recurring sales, but cloud-based investors are far more attentive to growth related to ongoing subscription revenue rather than one-time sources. Ultimate now gets five-sixths of its revenue from recurring sources. Customer retention rates stayed fairly strong, falling a single percentage point to 96% on a year-over-year basis.

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Ultimate was pleased with the acclaim that it has earned from the industry. The company highlighted its top rating from independent researchers at HfS Research, which praised Ultimate's performance in the predictive people analytics area of human capital management. High rankings for treating employees well and strong customer service also helped validate Ultimate's business model.

CEO Scott Scherr was pleased with the ongoing progress that Ultimate continues to make. "We executed on our top-level financial objectives as planned in the first quarter this year," Scherr said, and that succeeded in "putting us in good position to achieve our future goals." The CEO also stressed the innovative spirit that has helped foster growth for the cloud-based company.

What's next for Ultimate Software?

New offerings could lead to even better results in the future. Scherr discussed the unveiling of the Xander artificial intelligence platform, which it says gives clients the ability to understand workers better by looking at survey responses and analyzing business statistics. Audiences at the Connections customer and partner conference seemed impressed with the platform, and it has the potential to drive further business going forward.

However, Ultimate's sales guidance for the current quarter was a bit weaker than investors had hoped to see. The HR cloud company sees recurring revenue coming in at $196 million, with total revenue of $228 million, up about 23% from year-ago levels. Given Ultimate's extremely high valuation, even the single percentage point shortfall in anticipated growth rates is enough to make some investors concerned, making it crucial for the company to do what it can to grow more quickly if possible. Yet for the full year, Ultimate still expects overall sales growth of 24% and recurring revenue gains of 25%.

Ultimate Software's shareholders expressed their dissatisfaction with the company's results, and the stock was down about 4% in after-hours trading following the announcement. Investors have to decide whether Ultimate's huge growth potential is worth the premium valuation the stock currently fetches. For those who are more excited than nervous about the cloud's future prospects, Ultimate is putting itself in position to keep expanding well into the future.

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Dan Caplinger has no position in any stocks mentioned. The Motley Fool recommends Ultimate Software Group. The Motley Fool has a disclosure policy.