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Ultimate Software Company Viability Review

The highly competitive Human Capital Management (HCM) software market has proven a trying arena for even the most sizeable and stalwart of companies. Oracle faces doubts about the delivery of its much-trumpeted Fusion offering, while SAP tries to rally support around SuccessFactors and the cloud; all while Workday focuses on trying to fend off imitators who stand in the way of the company developing a lead in the HR technology innovation space. Ultimate Software's challenge has been slightly different—to reinvent themselves as a modern HCM software offering in order to go toe-to-toe with the big 3 (SAP, Oracle, and Infor) as well as an increasing number of midmarket competitors. In large part this meant investing heavily into a SaaS development and infrastructure—and migrating customers one-by-one to a SaaS environment while maintaining those that preferred the original model.

Of course the company's relatively small size compared with competing software companies (and those companies' much larger R&D departments) has been a constant challenge—a challenge that the company has addressed by focusing not only on the actual HCM technology but also on how that technology is created. Specifically, starting in 2004, software development at Ultimate was changed to reflect the company's advent of "Lean" processes and flat management structures; an effort that was geared towards the fostering of high-performance development teams.

Lead by Ultimate's CTO (Chief Technology Officer), the transformation of company development efforts were transfixed on making Ultimate's IT department a "Partner Player" organization—a Forrester distinction that is the culmination of 3 separate archetypes and the pinnacle of IT efforts to be a reliable, trusted, and strategic partner in technology. This initiative was seen as a chance for the company to gain significant competitive advantage in the market by markedly decreasing turnover and improving the attraction/retention of top IT talent for its 225 person-strong development workforce. Ultimately (no pun intended), the company modified the iterative framework known as Scrum to achieve these goals, creating self-contained teams with highly autonomous and business-focused goals that played well to the strengths of the high-performing employees the company was after. Further, Toyota's Kanban technique for just-in-time customer delivery was also introduced as a way to seat customer demand at front-and-center of the process.

These foci on expert staffing and customer service have proved invaluable to Ultimate Software's strategy, and even though the company is still effectively split between its licensed and SaaS offerings, according to I/B/E/S Estimates, "analysts are expecting the Company to report revenues of $73 million for the fourth quarter of 2011; revenues of $270 million for fiscal 2011; [and] revenues of $323 million for fiscal 2012"—a clear sign that the company is forging ahead with impressive growth. Further, Interactive Data highlights the fact that for the prior 5 years Ultimate Software exceeded 5-year averages for Gross Margin and Operating Margin by 40 and 190 base points respectively. Net Margin however, delivered lower than the 5-year average by 390 base points. While this is news that appears to be more in line with the needs of equity stakeholders, it should be noted that continuing investment is a harbinger for market confidence. Considering that Ultimate is one of the few HR software companies that has successfully bridged the gap between on-premise offerings and Software-as-a-Service deployments, it's no surprise that Interactive Data is quoted as saying "With recent TTM operating margins exceeding historical averages, Ultimate Software Group looks to be doing fine." Indeed, even according to Roth Capital's Nathan Schneiderman, "Ultimate [Software] remains among our fastest SaaS revenue-growth stories, and it still remains our top medium-term operating margin expansion story."

The "Ultimate" Future

Given these assessments then, it's surprising but not unheard of that the company may be shopping for new ownership—perhaps in the same vein as countless other venture capital-backed players. Indeed, several industry insiders have alluded to the fact that Ultimate Software has contracted with independent investment bank Lazard Group to shop the company. If correct, this is a move that has several implications. One, if sold to an investment company, Ultimate could simply gain access to much-needed physical and financial resources—bolstering the company's strategy to take on larger enterprises than the company currently services. If, on the other hand, the company winds up being acquired by a competing organization, the solution would be rationalized among other software products and could potentially die on the vine or get absorbed into a flagship product. Regardless of path or outcome though, valuations across the HR software space are extremely high, which could mean easy money for Ultimate shareholders if the company's current market value remains near $1.25B.

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