The Ultimate Software Group's CEO Discusses Q4 2013 Results - Earnings Call Transcript

Feb. 5.14 | About: Ultimate Software (ULTI)

The Ultimate Software Group, Inc. (NASDAQ:ULTI)

Q4 2013 Earnings Conference Call

February 4, 2014; 05:00 p.m. ET

Executives

Scott Scherr - Chief Executive Officer, President and Founder

Mitchell Dauerman - Executive Vice President & Chief Financial Officer

Analysts

Michael Nemeroff - Credit Suisse

Justin Furby - William Blair & Company

Richard Baldry - Roth Capital Partners

Richard Davis – Canaccord

Gregory Dunham - Goldman Sachs

Scott Berg - Northland Capital Market

Brad Reback - Stifel, Nicolaus

Mark Marcon - RW Baird

Pat Walravens - JMP Securities

Kirk Materne - Evercore Partners

Michael Huang - Needham & Company

Jeffrey Houston - Barrington Research

Steve Koenig - Wedbush Securities

Operator

Hello and welcome to Ultimate’s Fourth Quarter Year End Financial Results 2013 Conference Call.

At this time all participants are in a listen-only mode. Today’s conference is being recorded. Your presenters today will be Mr. Scott Scherr, Chief Executive Officer, President and Founder of Ultimate; and Mr. Mitchell K. Dauerman, Executive Vice President and Chief Financial Officer. We will begin with comments from Mitchell Dauerman. Please go ahead.

Mitchell Dauerman

Thank you, Corina. Good afternoon and thank you for your interest in Ultimate Software. Before we begin, please be aware that we will be discussing our business outlook and we’ll be making other forward-looking statements regarding our current expectations or future events and the future financial performance of the company.

These forward-looking statements are based upon information available to us as of today’s date and are subject to risks and uncertainties. We encourage you to review our filings with the SEC for additional information on risk factors that could cause actual results to differ materially from our current expectations. We assume no duty or obligation to publicly update or revise any forward-looking statement, whether as a result of new information, future events or otherwise.

I'm going to begin by reviewing our financial results for the year and for the fourth quarter 2013 and then I'll discuss our guidance for 2014. Unless otherwise noted, our discussion will be on a non-GAAP basis for all costs, gross margins, operating and net income, as well as EPS.

The primary difference between GAAP and non-GAAP financial information is non-cash stock-based compensation and the amortization on acquired intangible assets. Please refer to the reconciliation of our financial information on a GAAP basis to that on a non-GAAP basis included in the press release published on our website.

For the year, total revenues grew 23.5% to $410.4 million and recurring revenues grew by 25.5% to $334.4 million. Total gross margin was 60.7% compared with 58.1% to 2012. Operating income increased by 54% to $76.3 million and the operating margin for 2013 expanded by 370 basis points to 18.6%. Net income was $46.5 million, and the related net earnings per diluted share were $1.60.

Our cash flows from operating activities for 2013 grew 78.1% to $74.2 million from $41.7 million in the prior year. The average daily float balance of our tax filing business was $400 million.

For the quarter total revenues grew by 21.4% to a record $111.9 million, and the recurring revenues grew by 23.1% to $90.4 million. Total gross margin was up to 62.4%, compared with 59.7% for the fourth quarter 2012. Operating income increased to $23.3 million and our operating margin for the quarter was 20.9%.

Net income was $15.9 million and the related net earnings per diluted share were $0.54. Our quarterly recurring revenues results were above our expectations due to a combination of earlier product starts and higher growth in our customers’ employee counts than we had expected.

Our recurring revenue gross margin is 74.4%. It was also slightly better than our expectations for the same reasons. As expected, the quarter-over-quarter growth rate was impacted by a strong fourth quarter last year, which included two large customer starts.

Service revenues were $21.6 million and the related gross margin was 12%. Both exceeded our expectations, but were consistent with our better than expected return revenue results. Sales and marketing costs were higher than expected, as we increased our advertising and marketing cost and increased the size of our inside sales rep program.

Research and development costs reflected in the P&L were less than we had expected. This was due to a decision to accelerate our investment in the next generation of our product offering, as a result of a positive response we received from the introduction of the recruitment module.

Operating income was $23.3 million and our operating margin was 20.9% for the quarter. Our higher than expected total revenues accounted for the majority of the increase in operating margin for the quarter.

The impact of the acceleration of capitalized R&D cost was approximately 1% on the operating margin. Net of tax, this had an impact of $0.02 on fully diluted earnings per share.

Our non-GAAP income tax rate for the year was 38.9%. In the fourth quarter we recorded a previously unrecognized $1.9 million tax benefit as a result of the conclusion of an IRS exam. This benefit increased fully diluted earnings per share by $0.06 this quarter. Our non-GAAP income tax rate for 2013, excluding this benefit, was 41.5%.

Before I discuss the balance sheet, I wanted to discuss two recently completed acquisitions, which are expected to extend our reach in the human capital management arena and enhance our overall value proposition.

In October we acquired EmployTouch, a Toronto based firm that developed TouchBase, a market leading, tablet-based time collection and employee self-service device. This transaction aligns with Ultimate’s mission to simplify peoples work life with comprehensive solutions, not just for the HR payroll professionals, but for every employee within the organization, by providing hourly workers, their managers and others time and pay related information that is important to them.

In November we purchased certain assets of liability of AccelHR, which is based in Alpharetta, Georgia. Since 2007, AccelHR has partnered exclusively with Ultimate to provide managed HR, payroll, and benefits services to UltiPro customers in the middle and large markets throughout North America in diverse industries. Ultimate’s acquisition of AccelHR increases the range of services that Ultimate offers to its customers.

We paid $30.9 million for these two acquisitions, of which $25 million was paid in cash. The balance was paid in unregistered common stock, issuable over a three-year period. After taking this into account, our cash and marketable securities balance at year-end was $90.2 million.

Our capital expenditures in 2013 were $30.4 million, including capitalized R&D cost of approximately $17.6 million. This compared with $17.3 million in capital expenditures for the same period last year and those included $4.7 million of capitalized R&D cost.

We used $18.1 million in 2013 to acquire roughly a 143,000 shares of our common stock, to settle employees’ tax withholding obligations associated with the restricted stock that vested during this period.

We have 946,000 shares available for repurchase under our stock repurchase plan. Accounts receivable increased to $85.7 million, compared with $70.8 million at the end of 2012. DSOs were 70 days, down one day from last year.

Current deferred revenues were $102.7 million on December 31, compared with $90.7 million last year. Long-term deferred revenues were $500,000 compared with $1.3 million last year, reflecting the continued impact of the elimination of one-time infrastructure fees in our cloud contracts.

Next I'd like to talk about our guidance. For 2014 we expect to grow recurring revenues by approximately 25%. We have over 95% visibility into this goal. We expect the related gross margin to increase slightly from 2013 as we continue to make investments in our cloud business. We expect total revenues to grow by approximately 23% and service margins to be consistent with 2013.

As discussed earlier, we are accelerating our investment in the next generation of our product offering Version 14. As a result of this increase, we are revising our operating margin expectations to 20% from 19% in our preliminary guidance provided a quarter ago, as the R&D cost in the P&L are expected to be lower.

Total capital expenditures including these capitalized costs are expected to be between 9% and 10% of 2014 revenues. Our non-GAAP tax rate for 2014 should be approximately 41.5% and diluted weighted average shares to be approximately $30 million.

Now turning to the outlook for Q1 of 2014, we expect recurring revenues to be approximately $96 million and total revenues to be approximately $190 million, with our operating margin at approximately 17%.

In looking at our cost from a sequential quarter basis, from Q4, ’13 to Q1 ’14, its important to remember our usual patterns and we have higher costs in the first quarter, mostly due to employment related expenses, particularly higher benefits, typically of the beginning of each year compared with the fourth quarter of each year. In addition Q1 includes higher sales costs related to our annual sales kick-off release.

Turning to our upcoming conference schedules. During the next quarter Scott and I will be CSFB Technology Conference and Goldman Sachs’s Growth Conference in San Francisco on February 11 and 12, and then we’ll be at the Roth Capital Growth conference in Dana Point on March 10.

I will be at the R.W. Baird conference in New York on February 26; the JMP Tech conference in San Francisco on March 3; Morgan Stanley Tech conference also in San Francisco on March 4, and the Raymond James conference in Orlando on March 5. If you’re available at those conferences to meet, please let me know.

And now I’ll turn the call over to Scott.

Scott Scherr

Thank you Mitch and thank you everyone for participating in our call this evening. Ultimate had a landmark year in 2013. In 2012 we passed the $300 million milestone in total revenues. In 2013 we passed the $400 million mark and we are positioned to pass the $500 million mark in 2014.

In 2013 we increased our recurring revenues by 26% to a record $334 million and total revenues by 24% to $410 million. Our operating margin was nearly 19% for the year and our highly important customer retention rate was once again greater than 96% for the year. The total number of people records in our customer cloud is now more than 15 million.

In January I attended the annual meetings of our enterprise and mid market sales teams. We celebrated the best quarter and year in our sales history. We are extremely enthusiastic about opportunities in 2014 and beyond. Both teams are excelling at communicating the value of the full scope of our offerings.

Our enterprise teams that saturates for the fourth quarter were recruitment 84%, a record quarterly high in our history, on-boarding 84%, also a record quarterly high; performance management, 72% and time management 84%, another record quarterly high.

Some of our new enterprise customers in the fourth quarter were the healthcare organization with 16,000 employees that added recruitment on-boarding and time management. A technology company with more than 5,000 employees that added recruitment on boarding performance management, salary, planning and budgeting and global; a media company with more than 5,000 employees, that had a recruitment on-boarding performance management, time management and succession management.

A hospitality company with 4,400 employees that added a recruitment on boarding performance management, time management and succession management and an insurance company with more than 3,000 employees that had a recruitment on-boarding performance management, succession planning and time management.

We started our workplace sales team in the second half of 2006 and took our first workplace customer live in 2007. On January 9 of this year we took our 1,000 workplace customer live. We now call our workplace team mid-market. Our mid-market team has become an experienced veteran team and they execute consistently. Q4, 2013 was the best quarter every in the teams history.

Beginning with this year, our mid market team will target companies with 500 to 1,500 employees inside. Right now we have a 6% share in that space. Our very experienced, highly tenured enterprise team will be able to focus on those companies larger than 1500 employees. We have approximately 8% of this enterprise market right now.

Our mid-markets fourth quarter attach rates remain strong with recruitment at 77%, on boarding 82%, performance management 82%, and time management 78%. Some new mid market customers in the fourth quarter were a technology company with 1,000 employees that added on boarding time management, performance management and salary planning and budgeting; an energy company with approximately 1,000 employees that added recruitment on-boarding performance management and time management. A global services company with approximately 1,000 employees that added performance management on-boarding, time management, salary planning and budgeting and succession management.

A leading consulting services firm with 975 employees that had a recruitment on-boarding performance management, salary planning and budgeting and succession management and another services firm with more than 900 employees that had a recruitment, on-boarding performance management, time management, salary planning and budgeting and succession management.

We also had continued success in the fourth quarter with our customers moving from on-premise to the cloud. Some examples are Alliance Computer Services with 58,000 employees, Cambridge Quality Care with 28,000 employees, SkyWest Airlines with 20,000 employees, Jordan Healthcare holdings with more than 14.000 employees and Raycom with 5,000 employees.

At the end of Q4, our maintenance revenue from our onsite customers was down to 2% of our annual recurring revenues. Our marketing metrics indicate that market demand is increasing. In Q4, 2013 we have the highest number of responses ever from companies with more than 400 employees, reporting that they are looking to purchase a new ACM solution within 12 months or less. That translates to a 32% increase over Q4, 2012.

For these same, looking to buy responders, we had a 30% increase for the 2013 year versus 2012. Our inside sales team had a 67% increase in leads in Q4 ’13 over Q4 ’12. For the year it had a 46% increase.

For our website our unique visitors were up 28% for the quarter compared with last years Q4. It was the highest number in our history for our fourth quarter and Q4 beat both Q2 and Q3 in 2013. This is a very positive trend, considering that Q1 is typically our best quarter for web traffic due to the Fortune’s Best Companies To Work For announcement in January. For the year our website unique visitors were up 43%. We also had 64% year-over-year increase in thought leadership speaking engagements, both in terms of total number of speakers and total number of events.

Our Partners for Life program continues to perform as it was designed to do, contributing to great customer satisfaction and widening our circle of influence. In 2013 we had a total of 29,000 attendees in our education classes. Of those 8,800 were unique students from our customers; 70% of our customers’ trained people with us in 2013 and our unique students account was up by 13% over 2012. According to our full survey, 86% were satisfied or very satisfied with the experience. Flexible online classes make it possible for us to accommodate these numbers.

In our product development area, we expanded UltiPro’s Global HCM capabilities further, including global payroll integration and additional language support. We introduced a visual platform configuration interface that helps customers make frequently needed system changes to achieve a highly tailored HCM solution, without requiring technical resources.

We are also set to release our new UltiPro’s Recruiting Solution in the second quarter of this year. It is unique in the industry and that it is designed to attract and keep top talent engaged with the technology. It is candidate centric as opposed to recruiter-focused and has an appealing, flexible consumer-style user interface that is state-of-the-art and innovative.

We have begun to offer our customers UltiPro TouchBase, an interactive mobile time clock device that collects time punches and enables our customers to capture employee time on a touch screen tablet device for payroll and cost accounting. Customers can leverage photos for accurate capture of employee time-entry, preventing ‘buddy punches,’ and can validate transactions using PIN entry, HID, RFID, magnetic swipe or barcode.

We have also begun to offer our customers a new set of service offerings known as UltiPro Managed Services. UltiPro Managed Services allows our customers to have our team handle select components of HR, payroll and benefits management for them and to tailor the service package to suit their unique needs. We had some third party recognition in the fourth quarter and more recently.

In November 2013 Ultimate was named a Gold Winner in the category Best New Product Feature of the Year by the Best in Biz Awards, the only independent business awards program judged by members of the press and industry analysts. We won the award for our UltiPro Retention Predictor, a tool designed to give HR professionals and managers the ability to forecast an employee’s intent to remain with or leave the organization.

This feature uses an algorithm powered by 50 key indicators and enables leaders to better understand work force dynamics, proactively intervene as needed and build programs that foster long term employee relationships. Other Gold Winners in the Best in Biz Award were Dell, Hewlett-Packard and Sandisk. Our UltiPro Retention Predictor also won a Gold Award in Brandon Hall Group’s category for Best Advance in Unique Talent Technology in January 2014.

In November 2013, Nucleus Research, the leading analyst for measuring the operational value of technology named Ultimate a “Leader” in its HCM Technology Value Matrix. In January this year, for the second year in a row, Ultimate was recognized as one of the Achievers 50 Most Engaged Workplaces in the United States.

Last month Ultimate was ranked #20 on FORTUNE magazine’s 2014 list of Best Companies to Work For. This was our third year to be evaluated to the list and build on a #9 rank on the 2013 list, #25 on the 2012 list and our two #1 rankings on the medium Great Place to Work list in 2008 and 2009. We are again honored to be the only human capital management provider on the list since the high performance culture of engaged, talented people is at the heart of our products and service excellence.

Some of the country’s best-known and more successful companies are on the 2014 list; Google, American Express, Adobe, Intel, Microsoft, Mayo Clinic, Salesforce and Goldman Sachs. We are pleased to also congratulate our customers that are also on the list. Adobe Systems, Baker Donelson, Camden Property Trust, The Container Store, Cooley LLP, David Weekley Homes, Island Software, JM Family Enterprises, Kimley-Horn and Associates, NuStar Energy, Perkins Coie, Quicken Loan, TD Industries and of course Google, who we congratulate and respect for being #1 for the last three years.

We finished the 2013-year 1,931 strong. We have more than 15 million employee records in the cloud and lead the cloud industry in numbers of customers, using a strategic unified human resources payroll, talent, compensation and time and labor management solution suite. We continue to expand our cloud based human capital management suite and to innovate to better serve our customers. We have many long tenured, loyal customers who advocate for us and stand with us as we grow our business.

We begin 2014 with confidence in reaching our goal to exceed $500 million in revenues for the year, putting us on track to achieve our fourth championship goal of greater than $600 million in 2015. Our formula for success is the same as it’s always been: take care of our people and they in turn will take care of our customers by delivering the highest quality products and services. This has been our blueprint since Ultimate’s inception and will continue to drive our decision making as we move into the future as well.

This is Mitchell’s and my 64th conference call together. We want to thank you for your support over this time and look forward to your continued support in the future.

Let’s go to the Q&A.

Question-and-Answer Session

Operator

(Operator Instructions). First we’ll go to Michael Nemeroff with Credit Suisse.

Michael Nemeroff - Credit Suisse

Hi guys, congratulations. Nice year and a very strong end to the year with a good Q4.

Scott Scherr

Thank you, Michael.

Michael Nemeroff - Credit Suisse

First question for Scott, I guess in the past you talked about moving a little bit further down to the lower end of the mid market. Could you help us understand how low you are going to go and in terms of the go-to market strategy, how are you going to do that?

Scott Scherr

Yes, we’re calling it our strategic channel, 499 employees. By the second half of this year we’ll determine if we’re going to through a distribution network or we’re going to do it ourselves with the direct sales force. I think we are talking to people right now to see if there’s something we believe is in the best interest of the people we’re talking to in for Ultimate software, then we’ll go to the distribution route. If that doesn’t work out, then we’ll put our own team down there by the end of the year.

Michael Nemeroff - Credit Suisse

That’s helpful. And then also I just wanted to ask about the acceleration of the development of the new platform. What’s causing the acceleration above or faster than you originally had expected.

Scott Scherr

Well I think we accelerated it last year as we started seeing the response to the recruitment module, so it started developing last year and then became clear to us that any delay would be unwise and we should be fully staffed and if possible with quality to get to the next module that we want, so…

Michael Nemeroff - Credit Suisse

And when should we expect the core payroll product, the new module out?

Scott Scherr

I mean that’s – the next thing coming, which we did anticipate coming, but because of the investments we’ve made and the quality of our team, I believe we’ll have on-boarding before the end of the year.

Michael Nemeroff - Credit Suisse

That’s great. And one for Mitch if I may just looking at the size of the acquisitions, just how should we think about the contribution from AccelHR in 2014 in terms of revenue contribution and if you could just maybe give us a sense of what it contributed in Q4?

Scott Scherr

Yes, keep in mind we closed in November 15. The Accel had a fairly low run rate already on revenue, so giving the effect of Q4 would be absolutely nominal. And even next year, it’s not going to have that much of an impact, because just like in any type of recurring revenue business, we expect bookings to grow rapidly. We think it’s a great fit, but it takes time for the revenue to layer in, so we’ll probably see more of an impact from the combination of Accel, which we call UltiPro Managed Services and probably more so in 2015, 2016.

Michael Nemeroff - Credit Suisse

That’s great. And will there be -- is that going to help the services margin at all in ’14?

Scott Scherr

Well, our guidance was flat, so it probably stays around the same.

Michael Nemeroff - Credit Suisse

Okay, great. Thanks very much for taking my questions guys.

Scott Scherr

Thanks Mike.

Operator

And next we’ll go to Justin Furby with William Blair & Company.

Justin Furby - William Blair & Company

Hey guys, thanks for taking my question. I guess back on the strategic channel, I guess to the extent that in the second half of the year you decided to go at this market direct, how does that impact your guidance that you’ve set out today for fiscal ’14 and then going forward?

Scott Scherr

I think as we get there we’ll address it. As you begin to layer on people, it’s kind of a premature Justin because we haven’t decided to go that route, but basically your paying a sales person, a manager and so on as you build teams. But, that will start in the back half of the year, so I think it will be absorbed in the guidance that we have already.

Mitchell Dauerman

I’m confident that it will be absorbed in the guidance if we go that way.

Justin Furby - William Blair & Company

Okay, I guess is there anyway to weight the odds today Scott, maybe some of the conversations you’ve had thus far of you guys getting in at some level direct versus just completely using a third party. What’s your best guess today?

Mitchell Dauerman

70/30 that we’ll use third party.

Justin Furby - William Blair & Company

Okay, without you guys being involved at all, other than from a support standpoint.

Mitchell Dauerman

Well, I mean we’ll be involved, because we as a partner will do everything we can to make them as successful as possible.

Justin Furby - William Blair & Company

Okay, that’s helpful. And then so the inside sales rep that you continue to add, those are all in your mid market and enterprise team then, is that right?

Mitchell Dauerman

Yes. Last year they were – one inside sales rep covered six sales people and I mean it was successful almost from the get go, so we rapidly grew at the second half of the year and we’re going into this year with one internal sales rep taking three sales people. So we’re one to three versus one to six last year. They are definitely making a difference.

Justin Furby - William Blair & Company

And is that like a big factor? It sounds like Q4 just across the board was solid. Is that a big driver in that or I guess what drives the out performance that you guys saw last quarter from a bookings stand point?

Scott Scherr

The mid market has like I said the best quarter in the history. Enterprise came in as expected and I think we have two really good teams, a lot of tenure and I think it certainly helped. I think the recruitment module helped, you know the new stuff helped and I think every quarter we get stronger.

Justin Furby - William Blair & Company

Okay.

Scott Scherr

I gave you the marketing metrics, but those are real metrics, so we’re getting into more opportunities than what we said. The more opportunities we get, the more processes we can run, the more business we’ll get.

Justin Furby - William Blair & Company

Okay, just the last question from me on the pricing environment. What did that look like in terms of new deals for Q4?

Scott Scherr

It was consistent. There was nothing different.

Justin Furby - William Blair & Company

Okay, great. Thanks very much guys.

Operator

Moving on to Richard Baldry with Roth Capital Partners.

Richard Baldry - Roth Capital Partners

Thanks. With the interim sales group lead gen up over 70% in Q4 and was well ahead of the average for the year, you think there’s any risk that your sales rates will start to close quicker and you could find yourself sort of behind the ball on the implementation side and your gearing up for a growth rate that’s locked below the lead generation growth rate.

Scott Scherr

No, I don’t think that. I think the one where we do have third party. They’ve been partners with us for a while. We do have a very good channel of third parties. We did a while ago to make it elastic, so if they were ever, was like Q4, if we had this great quarter that we would be able to take care of those new customers and that’s what we did in Q4 and I think we’re positioned to do that in the future.

Richard Baldry - Roth Capital Partners

And when you look at the new potential for the strategic channel, when you think of the [long run turn] [ph] economics that channel would have once [people] [ph] go into the sort of smaller deals [inaudible] other companies [inaudible] [a hand][ph] in that channel and [factor in] [ph] effort, because they find that the cost to get the customers on versus their churn rate which tends to be a lot higher in the long run they just don’t find it attractive and [inaudible] in there and what do you think the long run [inaudible].

Scott Scherr

Well I think we’ve certainly tested it because when workplace, which is now called mid market when we started it was 200 to 600 and we were very successful in that and then we went 200 to 700 and 200 to 1000, and now you know – then we kind of went 400 to 1500. Now we’re kind of staying on 500. I believe what you’re talking about is more to the under 100 market, but our product and our suite of products certainly plays well to companies between 100 and 500 I believe.

Richard Baldry - Roth Capital Partners

Great. Thanks for the great quarter.

Scott Scherr

Thanks Rich.

Operator

Next we’ll go to Richard Davis with Canaccord. Richard Davis, please go ahead.

Richard Davis – Canaccord

Oh yes, sorry about that.

Scott Scherr

Hey Rich.

Richard Davis – Canaccord

When you guys moved to different markets areas, these are both 100 to 500 and the 500 to 1500, is it fair to say that at least initially you may have negotiations and stuff, but the price points are roughly the same and then the second core related question, if I take just the base payroll and I want to buy all of your kind of add-on apps, because I get this kind of number that’s probably two or three package, maybe three times bigger than my base payroll. I’m just trying to kind of think about the economics here, of your kind of motions in the different spaces. Thanks.

Scott Scherr

Its doubles the base pay, its double the core. The core is payroll, HR, employee self service, manager self service, so that’s what we call the core. We have the module, the opportunity to double the core and yes, the prices that we’re playing, its not like we are not playing in that market. We have been playing in that market for a while, so we have been getting, we have created a desire for a Unified HR payroll talent and timed products in that market, so its not a guess.

I mean we’ve been there and we’ve done it, so its about how do we penetrate the markets to a greater degree. Clearly we see three markets; 100 to 500, 500 to 1,500 and now the 1,500.

Richard Davis – Canaccord

Got it. That’s helpful. I just needed some clarity on that. Appreciate it thanks.

Scott Scherr

Thanks Richard.

Operator

Next we’ll go to Gregory Dunham with Goldman Sachs.

Gregory Dunham - Goldman Sachs

Hi, thanks for taking my question. Switching gears a little bit, when I look at the margin guidance that’s here, its pretty healthy. I guess what drove the shift there and how should we think about kind of the balance of growth in investment as you move beyond ’14; is it kind of as expected?

Scott Scherr

Greg, I missed the beginning part of your question.

Gregory Dunham - Goldman Sachs

The guidance on margins overall, operating margins, in terms of the expansion that’s embedded with guidance. Is the ‘14 kind of expansion what we should think about as we look out the next couple of years as well.

Scott Scherr

I think that we’re not giving guidance out that far, but yet that seems to be reasonable when you run through a model. Our goals have hit $600 million in revenue and $15 billion in ’18 and there’s macro expansion in the operating margin from there. So I think while we’re looking at 100 or so basis points this year, probably reasonable.

Gregory Dunham - Goldman Sachs

Okay, and I was hoping that – a different question. Obviously you’re recruiting, you’re moving forward with a number of different new products coming out next year. What in it has allowed, what in the product stack has allowed you to come out with these new products at a faster rate and is this something we should expect as you get beyond ’14 into 2015 in terms of the rate of innovation.

Scott Scherr

Yes, I think its easier to explain it as you know you build this, it takes a long time to build the foundation and once you get that foundation right and you get the system right, then it allows you to speed up. Then you invest in it and you can speed up the investment if the foundation is right and we spend a lot of time and a lot of money and a lot of talent on getting the foundation right, but then once it was right, it’s been great. I mean they are bringing out great stuff; we are looking at new stuff that’s great. I would never say on a call like this, that you know on-boarding is going to be up before the end of the year, because I never anticipated that until recently, but I think that’s exactly right. The speed of innovation now is going to be greater than its ever been with Ultimate Software.

Gregory Dunham - Goldman Sachs

All right, thanks guys.

Operator

Next we’ll go to Scott Berg with Northland Capital Market.

Scott Berg - Northland Capital Market

Hi Scott and Mitch, congrats on a good quarter. Yes, first question for Mitch. Mitch in your comments really you mentioned that the employee, that account was a little bit higher in the fourth quarter and most of your customers did not expect it. Maybe you can kind of say if they were temporary workers or if they are more full time workers and how we should think about that moving into ’14?

Scott Scherr

Yes, the [get backs] (ph) in our revenues is so small, we don’t spend a lot of time analyzing it. Our revenue growth comes from selling new customers retention. The rest of the stuff is pretty small. It just happened, there’s been a little bit of blend in the sale. If you take a look at the whole year, we did see better employment growth this year than last year, but we didn’t go through and dissect it.

Scott Berg - Northland Capital Market

Fair enough. And then Scott a housekeeping question on G&A; your G&A ticked up pretty nominally, sequentially from Q3 into Q4, much more so than in past years. Any reasons why does it move up and should we think about that as kind of the new level for 2014?

Mitchell Dauerman

Well, it’s the acquisition costs that happened in the fourth quarter. It’s probably a big part of it and then just natural growth.

Scott Berg - Northland Capital Market

Fair enough. I’ll hand it over at that moment. Thanks.

Scott Scherr

Thank you.

Operator

Moving onto Brad Reback with Stifel, Nicolaus.

Brad Reback - Stifel, Nicolaus

Hey guys, how are you?

Scott Scherr

Hi Brad.

Brad Reback - Stifel, Nicolaus

And I’m sorry if I missed this earlier in the call, but could you give us an update of where things stand with your international relationship with your vendor and how things are progressing on that front?

Scott Scherr

I think they completed the interface. They are working with us, they have for a while now and have clients who are using UltiPro and using them for their international payroll employees, so its getting stronger.

Brad Reback - Stifel, Nicolaus

Great, thanks a lot.

Scott Scherr

Okay sure.

Operator

Now we’ll go to Mark Marcon with RW Baird.

Mark Marcon - RW Baird

Good afternoon and congratulations. With regards to pricing, how should we think about that over the next couple of years given your increased reputation within the market? Is that allowing you to raise prices a little bit more?

Scott Scherr

No, we don’t look at it as raising prices, we look at it as providing more value and if we could provide more value through new products or rewrite the existing products, then that’s – well that’s what our goal is and that’s what we’ll do, not raising existing prices as much as bringing out new features, new products to the markets.

Mark Marcon - RW Baird

What’s the rights to your sales force? How should we think about the expansion for ’14 and ’15 exclusive of the strategic channels in terms of enterprise and mid-market?

Scott Scherr

Yes, I think we done a lot in 2013 and the beginning right now. We’re right staffed where we want to be. We have a lot of new people. When you think about how it layers in, you have people who come in, for lack of a better word we call them freshman, then the next year they become a sophomore and then they become a senior.

So one of the keys is and its always bee the key to us, and I think our reason for our success is we’ve been able to get the freshman to sophomores to seniors and not have a lot of turnover. So as you do that, your average productivity per person keeps going up. So our goal has always been to pickup the best players we can, retain those players and increase their average annual productivity.

I think right now we are pretty – we think we are set to accomplish our goals for 2014 and I think we have maybe a 5% up-tick in it, in 2015 and that’ll take us to our goal of ‘16 and then we’ll see what happens in the strategic channel, which way we go, but we are in pretty good shape for the next two years.

Mark Marcon - RW Baird

Terrific. And then I missed it – nice, better than expected improvement in terms of gross margin on service side. What was behind that again please?

Scott Scherr

That margin, that was just higher than expected service revenues, kind of consistent with the return revenue coming in a little bit ahead.

Mark Marcon - RW Baird

Any particular area or just utilization?

Scott Scherr

Across the board both enterprise and the market did very well.

Mark Marcon - RW Baird

Great, thank you.

Scott Scherr

Thanks.

Operator

Next we’ll go to Pat Walravens with JMP.

Pat Walravens - JMP Securities

Great, thank you and congratulation you guys. What key points would you make for investors who are worried that the competition in the payroll industry is going to increase?

Scott Scherr

Well I wouldn’t normally. I mean I’d say we had 8% in the enterprise market and we have 6% of the mid-market and we have less than 1% of the strategic market. Like always, if we keep making our product better, we keep making support better and take care of our business, then we can grow that and reach our goal and break into $600 million in ’15 and $1 billion in ’18. I believe its up to us, our competition is really our self.

Pat Walravens - JMP Securities

Right, and then I believe January is really an important month for payroll right. How much of your bookings for the year end-up getting done in that month.

Scott Scherr

Very little.

Pat Walravens - JMP Securities

Really.

Mitchell Dauerman

Yes sure, because people are going through year-end. Year-end is a big event, so you close the year December 31, by the end of January you have to have your W2, so people are very busy in January.

Mitchell Dauerman

And its practically, as long as you’ve been covering us, Q1 is always the weakest bookings quarter.

Pat Walravens - JMP Securities

I counted it up and like this is my 41st earnings call.

Scott Scherr

Your 41st?

Pat Walravens - JMP Securities

Yes 41st.

Scott Scherr

How we feel, its our 64th together.

Pat Walravens - JMP Securities

Okay, thank you.

Operator

We will now go to Kirk Materne with Evercore.

Kirk Materne - Evercore Partners

Thanks very much. Really starting with cash rates on, especially in the enterprise business this quarter. I guess can you talk a little bit about just how much of that was you all executing well versus maybe just the market, the broader shift towards buying suites in general. I’m sure it’s a bit of both. I was wondering if you could just give some context around that?

Scott Scherr

Yes, I think its – I really would be guessing on it. I mean my gut is it’s a little of both and also on the recruitment, we’ve been showing the new stuff for a little while now. So its really been, its been a home run for us, the recruitment thing and then you know soon it will start showing on-boarding and I’m sure that will be a home run, even though our on-boarding rates were very high. The last time when they hire recruitment, they buy on-boarding along with it. Its very rare that you get someone who just buys one without the other because they are so tight together. Its really the talent acquisition of a company is on-boarding; first recruiting them and then on-boarding them.

Kirk Materne - Evercore Partners

That’s helpful and then maybe just on the AccelHR acquisition. I guess what prompted you guys to want to bring that in-house and sort of provide managed services yourselves and I guess what I guess percentage of segment of your customer base is that offering really applicable to. Thanks.

Scott Scherr

I mean they’ve been a great partner of ours for a long time, and they were growing, and it’s a business where if you grow, you have to then put people out there because they are managing the services, a lot of the clients and we had some success with them, good success in 2013 and just the opportunity presented itself. The two owners there we are very close with it and just kind of kept over conversations, would you want to be a part of us, you know and it came to be.

It was natural for us. We have clients that obviously their whole business was built around UltiPro. So all their clients are our clients and then I think one of the things in some areas, because they were Accel and they weren’t that large, that people you know, they would be hesitant to maybe do business with them.

So I think now that’s a part of Ultimate. There are people that are – we’ve already seen it you know. The pipeline has grown tremendously in just less than a month or two months, but just people who wouldn’t talk to them before are now are talking to them, because they are part of Ultimate and that customers who where in our pipeline, sales prospects in our pipeline, as well as people who they talk to and they get us into the pipeline. So it was a no-brainer once the opportunity presented itself and you really couldn’t be happier with it or their ream; they are Ultimate people. Anything else?

Kirk Materne - Evercore Partners

That’s it from me. Thanks.

Operator

Next we will go to Michael Huang with Needham & Company.

Michael Huang - Needham & Company

Thanks very much. Hey guys, just one question. Most of my questions have been answered already. So you noted some of the nice migration activity that you saw among some staff. I was wondering if you could share who some of the remaining logos might be, that several may hold them on premise and maybe kind of your view of whether or not these guys are going to migrate over their staff and maybe how many employees in aggregate are across the remaining set of customers.

Scott Scherr

Yes, I’m not going to do that. But like I said, there’s 2% less. We’ve already had some of them, and some of the larger ones signed already in January to get down to 1.8%. The total number of employees is somewhere is the mid-300,000, the number of employees, but again that represents 2% of our incoming revenue. I believe by June 30 we’ll be down to almost nothing, so we’ll know at that point. But I would think we would get some majority of them and some we won’t.

Michael Huang - Needham & Company

Can I ask to just – in generally when you’re migrating a customer from (inaudible) to staff, like what kind of the multiplier on annual contract value. Like how much does it go up as a result of moving the staff?

Scott Scherr

If they are on-site they don’t have any of our talent products, that’s a big thing. So a lot of them now have the opportunity to get our talent products and we do take our talent products in that, so it could go up significantly.

Michael Huang - Needham & Company

Great, thanks guys.

Scott Scherr

Okay.

Operator

And now we will go Jeffrey from Barrington Research.

Jeffrey Houston - Barrington Research

Hey guys, thanks for taking my questions. To start with, sorry if I missed this if you provided it already, but what’s the current flow balance?

Mitchell Dauerman

Jeffery, it was $400 million for last year.

Jeffrey Houston - Barrington Research

Okay, and then following up on an earlier question about the strong attach rates, have you considered selling the talent management suite independent of payroll, with also cross selling over the time payroll to those talent management customers.

Scott Scherr

No, its completely unified into the code, so we never thought – our strength is a unified HR payroll, along with talent, time, tax benefits, so never thought that. In whole history of Ultimate, we always thought that you have to have the core and then the more you can unify around the core, the better the product would be and more valuable it would be and it certainly worked.

Jeffrey Houston - Barrington Research

Got it, that makes sense. Thank you.

Operator

Moving on to Steve Koenig with Wedbush Securities.

Steve Koenig - Wedbush Securities

Hi gentlemen, thanks for taking my questions. I’d like to ask you for an update. I mean where are you getting the new customers from. Are you seeing the sections from the legacy packed, those applications that accelerate?

Scott Scherr

Yes, about 65% of our business comes from service growth and from the ARPs, its about 15% right now, so we have seen an up-tick in that.

Steve Koenig - Wedbush Securities

Do you expect that to keep going up?

Scott Scherr

I do. I think there are people in play and I think that the pot is being stirred, worked it, just to see more opportunities out there with the people selling through our goals, the SAPs, so…

Steve Koenig - Wedbush Securities

Fair enough. I’m sorry.

Scott Scherr

No, I do see that and it’s the fact that it has risen this year by 50% for us. It’s a smaller number, but its still rose by 50%.

Steve Koenig - Wedbush Securities

Okay. And then I’d like to get a little bit more color on your scripted remarks at the very outset. Mitch you attributed the revenue out-performance to – kind of mentioned higher employment at customers and then sooner than expected product starts. What do you mean specifically by the sooner than expected product starts. Can you give us more color on that?

Mitchell Dauerman

Yes, maybe if we had additional customer going live, they make them live a month or two sooner. It could be the attached rate from some additional like modules the customer bought and starting the recurring revenue sooner. If you put it in perspective, it’s a small amount of money.

Steve Koenig - Wedbush Securities

Yes, okay, that’s helpful. For the ones that go live, that went faster than expected. Okay and then just one last question for your guys, on your growth targets for 2015, which is about 20% I guess, it’s a little lower than this year. Is that just because visibility isn’t as good yet or simply because you are getting bigger.

Scott Scherr

I mean we’ve never given a growth target for ’15.

Steve Koenig - Wedbush Securities

Well, when you talk about $600 million cost of revenue.

Scott Scherr

Yes, breaking through $600 million. We’ve said that, I don’t know if it was four years ago that, when we set our goal. You know it took us 16 years to get to a $100 million and four years to get to $200 million, three years to get to $400 million and we’re just two years to get, you know breakthrough $600 million so, but we haven’t given any guidance for ’15.

Operator

Thank you. And we’ll take our last question from [Inaudible] with [Shilling Capital] [ph].

Unidentified Analyst

Great, thanks for taking my questions. Fist just some housekeeping questions. What was capitalized R&D in the quarter and what are you expecting that to be in your 2014 plan?

Mitchell Dauerman

The quarter was $6.7 million non-GAAP and $17.6 million for the year and we are estimating probably $26 million, $27 million next year.

Unidentified Analyst

Okay and should we, as you released recruiting, what are you expecting the amortization to be out of the current capitalized R&D balance in 2014.

Scott Scherr

It’s relatively small.

Unidentified Analyst

Great. Is there a way that you want...

Mitchell Dauerman

Aaron, as Scott mentioned when you’re developing a new generation the first step is the foundation. So the large investments in the foundation and then you have the product. So the product is going to be a smaller component of the amortization.

Unidentified Analyst

Okay, great. And then as you’re looking at the year 2014, how we’re thinking about the quarterly split, are there any kind of big customer starts that you want us to be aware of the timing?

Mitchell Dauerman

No, not at this time. The big customer that we announced was the signing event and that’s scheduled for the beginning of January.

Unidentified Analyst

Great, thank you.

Mitchell Dauerman

January 15 to be clear.

Operator

This does conclude our Q&A session. I’ll now turn the call over to Scott Scherr for any final remarks.

Scott Scherr

I appreciate all your time. Tomorrow is a big day at Ultimate. We are going to raise a flag for our third championship, $410 million and we are going to raise a flag for being the 20th best place to work for in America. So its been a great ride and I hope it gets better. Thanks for your support.

Operator

This does conclude today's conference. We do thank you all for joining us.

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Ultimate Software Group, Inc. (The) (ULTI): Q4 EPS of $0.54 beats by $0.13. Revenue of $111.9M (+21.4% Y/Y) beats by $1.33M.