Ultimate software a cash flow story is brewing – ultimate software group, inc. (the) (nasdaq ulti) seeking alpha gas near me now


Human capital management software, or HCM, is a tough space to be in. There are plenty of competitors and everyone is claiming to do something different, whereas the core functionality of all HCM platforms (at least from the point of view of an HR officer) is fairly simple: employee records, payroll, benefits, onboarding, time management, and the like. What differentiates them all, beyond a matter of preference for the user interface? Gartner, the leading independent analyst for the software industry, has forecasted a ~10% growth rate for HCM vendors through 2021 – by all measures, that’s a fairly strong growth rate. And while many of the pure-play SaaS HCM companies in the market are still growing in excess of that, we’ve seen deceleration start to bake into their results.

Ultimate Software ( ULTI), over the past several years, has become one of the top powerhouse vendors in HCM, at least among the pure-play names (aka, software vendors focused on HCM, not huge portfolio companies like SAP ( SAP) that offer HCM along with ERP, CRM, and dozens of other applications). Its recent Q1 results show a company that has been able to defy the deceleration trend for several years. Ultimate Software’s growth has hovered reliably in the ~20% range since 2014, without any meaningful spikes up or down. This is a company that has clearly found its niche serving mid-market enterprises (much like Netsuite’s finance and ERP software catered well to mid-market customers, before it was merged with Oracle’s enterprise-facing ERP features in a pricey 2016 acquisition).

The stock has shrugged off a slew of downgrades from analysts over the past month, most of whom cite valuation as the primary concern. In my view, however, Ultimate Software is hardly overpriced. The elephant in the room here is Workday ( WDAY), the dominant HCM software company that has perennially traded at double-digit revenue multiples. Of course, Workday is also growing at a ~30% rate despite being at about twice Ultimate Software’s size – but still, the valuation gap between the two companies is quite apparent:

Given that Workday trades four turns above Ultimate Software on a revenue basis, I’d say there’s plenty of room for Ultimate Software to march higher, even after considering its impressive year-to-date rally. One caveat here: Ultimate Software’s gross margins are lower than Workday’s (62.4% gross margin for Ultimate Software in FY18 versus 70.6% for Workday), as it has a greater portion of its revenue mix in professional services that are done essentially at cost. That means Ultimate Software‘s revenue stream is slightly less valuable than Workday’s.

Ultimate Software’s guidance, however, points its growth trajectory in the right direction, with FY18 revenue forecasted to grow "in excess of 17%" while FY18 recurring revenues (aka, non-professional services) are forecasted to grow "in excess of 20%". Note that Ultimate Software’s way of guiding revenues, setting a minimum growth rate, is quite a novelty compared to most software companies that give a simple dollar range. In any case, the more robust growth rate for non-recurring revenues means that Ultimate Software is working to grow its SaaS revenue mix, and thus its gross margin, over time.

In addition to the revenue piece, there’s also a lot to be said about Ultimate Software becoming a cash flow/earnings story. The company has been profitable on a GAAP basis for quite some time, but it’s also close to having is operating cash flows support its valuation. As also shown in the comparative chart above, Ultimate Software’s valuation at ~30x OCF is still rather steep, but still much better than approximately double that valuation at Workday. And with OCF growth outstripping revenue growth on top of vastly improved operating margins, a reasonable cash flow-based valuation for Ultimate Software is coming in the near horizon.

The bottom line on Ultimate Software’s stock: it’s certainly not cheap, but relative to other HCM names (in particular Workday) as well as other high-growth SaaS stocks, Ultimate Software does look appealing. The emergence of significant cash flows is another major bull catalyst to look out for. I’d use any Wall Street-induced pullback or other negative noise to build a position as Ultimate Software gets ready to run higher. Q1 recap: revenue beats, atop huge operating margin boost

Revenues grew 21.1% y/y to $276.8 million, actually accelerating 120bps over the company’s exiting Q4 growth rate of 19.9%. The fact that Ultimate Software was able to clock in >20% growth allows it to surpass a psychologically important threshold, as many analysts and investors are baking into their models a deceleration into the high teens (certainly, Ultimate’s own FY18 guidance calls for 17% growth). However, with the outperformance in this quarter, we can easily see full-year growth land in excess of 20%, especially if revenues continue to accelerate. Note also that Wall Street only expected revenues of $270.7 million in the quarter, or 18.4% y/y growth, putting Q1’s results at a respectable 250bps upside to consensus expectations.

Recurring revenues – essentially the revenue derived from SaaS, and the most important focus for the company – showed even stronger growth of 24.5% y/y in the quarter. As a percentage of total revenues, recurring revenues represented 85.5% in Q1, a significant improvement over 83.1% in 1Q17 – and as the company is continuing to forecast recurring revenue growth in excess of total revenue growth, the mix will continue to shift in the right direction. Mitchell Dauerman, the company’s outgoing CFO ( Felicia Alvaro, the company’s VP of Finance and a 20-year veteran of the company, succeeded him), attributed the outperformance to the following:

Recurring revenues exceeded our expectations for several reasons, including better than expected seasonal employment from our customer base compared to our modeling assumptions, and earlier than expected go-lives, as well as better than expected annual one-time recurring fees from our strategic partners."

Primarily due to this favorable mix shift into SaaS, Ultimate Software saw a 140bps boost to gross margin, posting 62.1% gross margins in the quarter versus 60.7% in 1Q17. Given that investors have been particularly picky on gross margin this quarter in the tech sector, and that Ultimate’s gross margin is already lower than the majority of its peer set, continued gross margin expansions will be key to the bull story.

Rolling it all into the bottom line, Ultimate Software posted pro forma EPS of $1.30, or 11% upside to analyst expectations of $1.13. And of course, this came on top of the cash flow growth that we’re anticipating so heavily from the company. Operating cash flows grew 22% y/y to $56.6 million, while free cash flows showed 43% y/y growth to $33.7 million.