Ultimate Software Group Inc. CEO SCOTT SCHERR bought 35900 shares on 11-03-2008 at $13.88
Ultimate Software designs, markets, implements and supports human resources (â€śHRâ€ť), payroll and talent management solutions principally in the United States.
Ultimate Softwareâ€™s UltiPro software (â€śUltiProâ€ť) is a comprehensive Web-based solution designed to deliver the functionality businesses need to manage the complete employment life cycle from recruitment to retirement. The solution includes feature-sets for talent acquisition and hiring, HR compliance, online benefits enrollment and management, payroll, performance management and appraisals, learning management, reporting and analytical decision-making tools, time and attendance, and a self-service Web portal for executives, managers, administrators, and employees.
Ultimate Software believes that UltiPro helps customers streamline HR and payroll processes to significantly reduce administrative and operational costs, while also empowering managers and staff to analyze workforce trends for better decision making, accessing critical information quickly and performing routine business activities efficiently.
Ultimate Softwareâ€™s hosted offering, branded â€śIntersourcingâ€ť (the â€śIntersourcing Offeringâ€ť), provides Web access to comprehensive workforce management functionality for organizations that need to simplify the information technology (â€śITâ€ť) support requirements of their business applications. Intersourcing is available to companies primarily on a subscription basis and is known in the industry as â€śsoftware-as-a-serviceâ€ť (â€śSaaSâ€ť) and on-demand. Ultimate Software believes that Intersourcing is attractive to companies that want to focus on their core competencies to increase sales and profits. Through the Intersourcing model, Ultimate Software provides the hardware, infrastructure, ongoing maintenance and backup services for its customers at two data centers, one located in the Miami, Florida area and the other in the Atlanta, Georgia area.
As part of its comprehensive HR, payroll and talent management solutions, Ultimate Software provides implementation and training services to its customers as well as support services, which have been certified by the Support Center Practices Certification program for nine consecutive annual evaluations. UltiPro leverages the Microsoft technology platform, which is recognized in the industry as a cost-effective, reliable and scalable platform.
UltiPro is marketed primarily through the Companyâ€™s direct sales team. Ultimate Software has approximately 1,600 customers as of the end of 2007. Based on December 2007 market data from Dun & Bradstreet, Ultimate Software estimates its approximate market share to be 3 percent of the 15,000 and larger employee space; 6 percent in the 700 to 15,000 employee space, and less than 2 percent in the 200 to 700 employee space.
In 2007, Ultimate Software began the expansion of its sales team for its new solution offering â€śWorkplaceâ€ť. Workplace is an offering of UltiPro targeted for companies with 200 to 700 employees in size and is a subscription-based SaaS solution that provides these medium-sized and smaller companies nearly all the features that larger enterprise companies have with UltiPro, plus a bundled service package. Workplace is designed to give customers a high degree of convenience since Ultimate Software handles system setup, business rules, and other situations for customers â€śbehind the scenes,â€ť and many companies of this size do not have IT staff on-premises to help with system issues.
As previously disclosed, Ultimate Software and Ceridian Corporation (â€śCeridianâ€ť) signed an agreement in 2001, as amended, granting Ceridian a non-exclusive license to use UltiPro software as part of an on-line offering for Ceridian to market primarily to businesses with less than 500 employees (the â€śOriginal Ceridian Agreementâ€ť). Ceridian marketed that solution under the name SourceWeb. During December 2004, RSM McGladrey Employer Services (â€śRSMâ€ť), a former business service provider (â€śBSPâ€ť) of Ultimate Software, acquired Ceridianâ€™s SourceWeb HR/payroll and self-service product and existing SourceWeb base of small and mid-size business customers throughout the United States (the â€śRSM Acquisitionâ€ť). The financial terms of the Original Ceridian Agreement did not change as a result of the RSM Acquisition. Subsequent to the RSM Acquisition, Ceridian continued to be financially obligated to pay, and did pay, Ultimate Software minimum fees pursuant to the terms of the Original Ceridian Agreement. The aggregate minimum payments that Ceridian was obligated to pay Ultimate Software under the Original Ceridian Agreement over the minimum term of the agreement aggregated $42.7 million. To date, Ceridian has paid to Ultimate Software a total of $42.1 million under the Original Ceridian Agreement. Ultimate Software expects to continue to recognize a minimum of $642,000 per month in subscription revenues (a component of recurring revenues) from the Original Ceridian Agreement until its termination date. The amount of subscription revenues recognized under the Original Ceridian Agreement during the year ended December 31, 2007, totaling $7.7 million, was the same as those recognized in 2006 and 2005. Effective March 9, 2006, Ceridian provided Ultimate Software with a two yearsâ€™ advance written notice of termination of the Original Ceridian Agreement, as permitted under the terms of the Agreement. Pursuant to such notice, the Original Ceridian Agreement terminated on March 9, 2008.
Ultimate Software is a Delaware corporation formed in April 1996 to assume the business and operations of The Ultimate Software Group, Ltd. (the â€śPartnershipâ€ť), a limited partnership founded in 1990. During August 2006, the Company formed a wholly-owned subsidiary, The Ultimate Software Group of Canada, Inc., to accommodate future operations in Canada. In October 2006, the Company acquired 100% of the common stock of RTIX Limited, a United Kingdom company, now known as The Ultimate Software Group UK Limited, and its wholly-owned U.S. subsidiary, RTIX Americas, Inc. (collectively, â€śRTIXâ€ť) (the â€śRTIX Acquisitionâ€ť). Pursuant to the RTIX Acquisition, the Company expanded business operations to the United Kingdom. Ultimate Softwareâ€™s headquarters is located at 2000 Ultimate Way, Weston, Florida 33326 and its telephone number is (954) 331-7000. The Companyâ€™s revenues for the year ended December 31, 2007 include revenues of RTIX, and, as a result of the RTIX Acquisition, the consolidated financial statements include assets in the United Kingdom as of December 31, 2007. There were no material assets or revenues in Canada as of December 31, 2007.
The Companyâ€™s revenues are derived from three principal sources: recurring revenues, services revenues and license revenues.
Recurring revenues consist of Intersourcing revenues from the Companyâ€™s hosted offering of UltiPro, maintenance revenues and, to a lesser extent, subscription revenues from per-employee-per-month (â€śPEPMâ€ť) fees generated by BSPâ€™s. Subscription revenues are principally derived from PEPM fees earned through the Intersourcing Offering, Base Hosting (defined below), and revenues generated from the Original Ceridian Agreement. Maintenance revenues are derived from maintaining, supporting and providing periodic updates for the Companyâ€™s products under software license agreements. To the extent there are upfront fees associated with the Intersourcing Offering, Base Hosting or the BSP sales channel, subscription revenues are recognized ratably over the minimum term of the related contract upon the delivery of the product and services. Ongoing PEPM fees from the Intersourcing Offering, Base Hosting and, to a lesser extent, sales provided from BSPâ€™s are recognized as subscription revenues (a component of recurring revenues in the consolidated statements of income) as the services are delivered. Maintenance revenues are recognized ratably over the service period, generally one year.
Services revenues include revenues from fees charged for the implementation of the Companyâ€™s software products and training of customers in the use of such products, fees for other services, the provision of payroll-related forms and the printing of Form W-2â€™s for certain customers, as well as certain reimbursable out-of-pocket expenses. Revenues for implementation consulting and training services are recognized as services are performed to the extent the pricing for such services is on a time and materials basis. Other services are recognized as the product is shipped or as the services are rendered, depending on the specific terms of the arrangement.
Arrangement fees related to services sold on a fixed-fee basis are recognized using the percentage of completion accounting method, which involves the use of estimates. Percentage of completion is measured at each reporting date based on hours incurred to date compared to total estimated hours to complete the implementation job. If a sufficient basis to measure the progress towards completion does not exist, revenue is recognized when the project is completed or when the Company receives final acceptance from the customer.
License revenues include revenues from software license agreements for the Companyâ€™s products, entered into between the Company and its customers in which the license fees are non-cancellable. License revenues are generally recognized upon the delivery of the related software product when all significant contractual obligations have been satisfied. Until such delivery, the Company records amounts received when contracts are signed as customer deposits, which are included with deferred revenues in the consolidated balance sheets.
Features of UltiPro
Ultimate Softwareâ€™s UltiPro product is an HR, payroll and talent management solution designed to increase overall efficiencies for managing the complete employee life cycle. UltiPro offers the following features to its customers:
Web Workforce Portal. UltiPro includes a Web workforce portal that can serve as a companyâ€™s communications hub and the central gateway for business activities. It provides functionality for everyone in the customerâ€™s organization, not just the human resources department. Ultimate Software believes that UltiProâ€™s workforce portal can increase administrative efficiencies by providing reporting, staff management processes and business intelligence to management over the Internet and can reduce operating costs by eliminating the need for organizations to print and distribute paper communications, handbooks, forms and paychecks.
Feature-Rich, Built-in Functionality. Based upon the amount of built-in and integrated functionality, the Company believes that UltiPro minimizes the need for extensive customizations or changes to source code, facilitates streamlined management of the total employment cycle, enables organizations to minimize the time invested in tactical, burdensome HR/payroll administrative activities, and provides strategic HR management reports and tools.
Implementation and System Update Efficiency. UltiPro has been designed to minimize the time and effort required for implementing, customizing and updating. UltiPro delivers an extensive amount of functionality â€śout-of-the-boxâ€ť so that few customizations are required by the typical customer. The Company also provides an implementation methodology, experienced implementation staff and customer training to facilitate rapid implementation. Ultimate Software continues to refine and improve its implementation process to enable its customers to implement more quickly than competitive solutions with comparable functionality. To facilitate customizations and fast system upgrades, the Company has designed UltiPro to allow customers to load system updates, and not overwrite their customizations because the system stores custom changes as sub-classed objects or data that reside â€śoutsideâ€ť the core program, thus avoiding the time-consuming process of rewriting custom changes.
Reduced Total Cost of Ownership. The Company believes that the UltiPro solution provides cost saving opportunities for its customers and that UltiPro, whether purchased as a license or as a service through Intersourcing, is competitively priced. In addition, the Company believes that its current practices in implementing the UltiPro solution result in a cost savings for customers when compared with implementations of other similar solutions in the industry. A customer may also reduce the administrative and information technology support costs associated with the organizationâ€™s HR, benefits and payroll functions over time. Tight integration helps to reduce administrative costs by facilitating accurate information processing and reporting, and reducing discrepancies, errors and the need for time-consuming adjustments. In addition, administrative costs can be reduced by providing an organization with greater access to information and control over reporting.
Leveraging of Leading Technologies. Ultimate Software has consistently focused on identifying leading technologies and integrating them into its products. The primary characteristics of Ultimate Softwareâ€™s technology are:
n Leading-edge service-oriented-architec ture (â€śSOAâ€ť) technology platform built using Microsoft .NET 3.0 framework; and
n Multi-tenancy (multiple companies can reside on one server):
The multi-tenant model allows each application component to run on a separate farm of load-balanced servers while still providing database isolation that customers demand. Ultimate Softwareâ€™s multi-tenant site registry functions similar to a â€śyellow pagesâ€ť to manage tenant location and isolation within the site.
n Connecting UltiPro via Web Services:
Through Web Services, Ultimate Software exposes appropriate surface areas of UltiPro to integrate with other applications and data services easily and securely regardless of firewall boundaries.
Ease of Use and Navigation. Ultimate Software designs its products to be user-friendly and to simplify the complexities of managing employees and complying with government regulations in the HR, payroll and talent management areas. UltiPro uses familiar Internet navigation techniques, which the Company believes makes its portal convenient and easy to use. A customerâ€™s executives, managers, administrators and employees have Web access to manage payroll and employee functions, run reports or find answers to routine questions. The Company refers to this easy navigation as â€śTwo clicks to anywhere.â€ť
Comprehensive Customer Services and Industry-Specific Expertise. Ultimate Software believes it provides the highest quality customer services, including on-demand hosting services, professional implementation services, knowledge management (or training) services and ongoing product and customer support services. Ultimate Softwareâ€™s customer support center has received the Support Center Practices (â€śSCPâ€ť) Certification for the ninth consecutive year. The SCP program was created by the Service & Support Professionals Association (â€śSSPAâ€ť) and a consortium of information technology companies to create a recognized quality certification for support centers. SCP Certification quantifies the effectiveness of customer support based upon relevant performance standards and represents best practices within the technology support industry according to SSPA. Recognizing the importance of issuing timely updates that reflect changes in tax and other regulatory laws, Ultimate Software employs a dedicated research team to track jurisdictional tax changes to the more than 12,000 tax codes included in UltiPro as well as changes in other employee-related regulations.
Ultimate Software seeks to provide its clients with optimum performance, advanced functionality and ease of scalability and access to information through the use of leading Internet standard technologies. The UltiPro solution was designed to leverage cutting-edge technologies such as XML and Web Services that use open standards to provide customers with a cost-effective platform for performing critical business functions rapidly over the Web and allowing different systems to communicate with one another. The use of Microsoft technology helps the Company to deliver what it believes to be a highly deployable and manageable payroll and talent management solution that includes the following key technological features:
Web-Based Technologies and Internet Integration. Ultimate Software supports emerging Web technologies and Internet/extranet connectivity to increase access to and usability of its applications. One of the highlights of UltiProâ€™s technology is the Companyâ€™s Distributed Process Management (â€śDPMâ€ť) framework, a framework that enables business functions to be performed in UltiPro Web (â€śUltiPro Webâ€ť), and allows different enterprise systems to talk to one another over the Internet. UltiProâ€™s DPM was designed to automate and distribute HR and payroll processes, for example, entering group time or generating reports, across multiple servers to reduce the amount of time and manual work required. The Company believes that the DPM framework makes UltiPro highly scalable to accommodate a high volume of processing requests cost-effectively, particularly for companies that run hundreds or even thousands of payrolls. UltiPro has a complementary backoffice component for handling payroll processing, company and system setup, and security.
Application Framework. Ultimate Software has designed certain aspects of its system using a multi-tiered architecture in order to enhance the systemâ€™s speed, flexibility, scalability and maintainability. When an applicationâ€™s logic resides only on a client workstation, a userâ€™s ability to process high volume data transactions is limited. When the logic resides only on a server, the userâ€™s interactive capabilities are reduced. To overcome such limitations, Ultimate Software built more separation into the application design to increase the extensibility, scalability and maintainability of the application. The UltiPro application consists of several core components in a layered architecture that leverages Microsoft technology. UltiProâ€™s multi-layered architecture, including an operating system layer, business logic layer, presentation layer and user interface layer, makes it easier to update and maintain UltiPro, as well as integrate UltiPro with other enterprise systems. The Company believes that UltiProâ€™s application framework provides a highly extensible set of services that can scale depending on the customerâ€™s business size. In addition, UltiPro was built using a data-driven, object-oriented application framework that enhances the development and usability of the solution. Object-oriented programming features code reusability and visual form/object inheritance, which decrease the time and cost of developing and fully implementing a new system. With object-oriented programming, system updates do not overwrite prior customizations to the system because custom changes are sub-classed objects that reside â€śoutsideâ€ť the core program.
Business Intelligence Tools. In addition to an extensive library of standard reports that offer flexibility and ease of use, the Company extends what users can do with employee data by embedding business intelligence tools from Cognos Corporation, a third-party provider (â€śCognosâ€ť). In addition to offering sophisticated data query and report authoring, these tools enable users to apply on-line analytical processing (â€śOLAPâ€ť) to multidimensional data cubes, allowing users to explore data on employees graphically and statistically from diverse angles. Ultimate Software maintains a link between Cognosâ€™ report catalog and UltiProâ€™s data dictionary, eliminating the necessity for users to create and maintain ad hoc reporting catalogs. A Cognos Web Package is delivered to UltiPro customers to allow users to access reports and conduct data queries from a Web browser.
Ultimate Softwareâ€™s UltiPro software (â€śUltiProâ€ť) is an end-to-end HR, payroll, benefits administration and talent management solution designed to fit the needs of organizations with 200 employees or larger. UltiPro delivers functionality businesses need to manage the complete employment life cycle, from recruiting and hiring the most qualified candidates, to managing benefits programs and compensation plans, to managing learning programs and performance reviews. All features are delivered through a centralized Web portal that is easy to access for businesses that are centralized at headquarters or distributed across multiple locations or branch offices. Ultimate Software believes that UltiPro helps customers streamline HR and payroll processes to significantly reduce administrative and operational costs, while also empowering executives and staff to find critical information quickly and perform routine business activities more efficiently.
UltiProâ€™s core functionality includes, but is not limited to, a business/employee portal, human resources, benefits administration, UltiPro business intelligence, payroll processing, manager self-service, employee self-service, administration and other key features such as, but not limited to, tax updates, tax filing, time clocks and the ability to interface with third-party applications and providers (â€śUltiPro Coreâ€ť).
In addition to UltiPro Core, the Companyâ€™s customers have the option to purchase a number of add-on products on a PEPM basis, which are available to enhance the functionality of UltiPro Core based on certain business needs of the customers. These UltiPro add-on products currently include (i) the talent management suite of products; (ii) benefits enrollment; and (iii) time, attendance and scheduling (collectively, â€śUltiPro Add-On Productsâ€ť), which are described below.
UltiPro Core includes, but is not limited to, the following functionality:
UltiProâ€™s Business/Employee Portal. UltiProâ€™s Web portal can act as the gateway to business activities for a companyâ€™s executives, management team, HR/payroll staff, administrators, and employees. Ultimate Software believes that UltiProâ€™s portal allows its customers to improve service to their employees through better communications and save time because managers and administrators can complete hundreds of common employee-related tasks, including administering benefits, managing staff and accessing reporting and business intelligence in real-time, from one central location. UltiPro also enables companies to provide on-demand access to company and personal information for their employees over the Web.
Human Resources. UltiPro tracks HR-related information including employment history, performance, job and salary information, career development, and health and wellness programs. In addition, UltiPro facilitates the recording and tracking of key information for government compliance and reporting, including Consolidated Omnibus Budget Reconciliation Act compliance; Health Insurance Portability & Accountability Act certificates; Occupational Safety & Health Administration and workersâ€™ compensation; Family Medical Leave Act tracking; and Equal Employment Opportunity compliance. UltiPro also enables compliance with the Health Insurance Portability & Accountability Act confidentiality legislation for protecting sensitive data such as employee social security numbers.
Benefits Administration. UltiPro allows companies to match all of the health, welfare, dental, vision, and other benefits that their organizations offer employees, set up and administer benefit plans and employee and employer contributions, and enables employees to check benefit options and coverage from the UltiPro portal. UltiPro eliminates the need for duplicate rules, duplicate data entry, and reconciliation reporting because it stores details for deductions and benefit plans in one common table. This includes rules for coverage, premium and employer match computations, and eligibility and participation determination. UltiPro also allows companies to maintain and administer paid time off benefits, such as vacation (including calculating benefit accrual amounts), track leave time taken, and facilitate the response to employee leave requests.
UltiPro Business Intelligence. Using UltiPro Business Intelligence tools, customers can provide their managers and executives with Web access to a library of hundreds of workforce-related reports, workforce analytics and point-in-time reporting, without installing reporting software on usersâ€™ PCs or writing custom reports. With UltiPro Business Intelligence, users can run and print pre-formatted reports for the executive team or run instant queries on the Web for answers to routine questions. UltiPro Business Intelligence also delivers workforce analytics to enable managers to evaluate workforce trends strategically on topics such as compensation, turnover and overtime.
Payroll Processing. UltiProâ€™s payroll engine handles hundreds of payroll-related computations intended to minimize the customerâ€™s need for side calculations or additional programming. For example, UltiPro delivers complex wage calculations such as average pay rates for overtime calculations, shift premiums, garnishments and levy calculations. With UltiPro, a companyâ€™s central payroll department, remote offices or multiple divisions can process payroll with specific processing steps based on the exact needs of the organization, and manage this process through a payroll processing dashboard within the UltiPro portal. UltiPro includes group time entry to allow customersâ€™ supervisors or managers to input and submit time at branch offices for their teams as well as employee based timesheets for employees to enter and submit their time to managers for review and approval.
Manager Self-Service. As authorized, managers have self-service access to staff information such as salary, compensation history, key dates and emergency contacts, with reporting and workforce analysis tools to facilitate decision-making. A customerâ€™s managers can view and update staff information, manage department activities, post job openings, leverage recruiting and hiring tools, and perform queries on workforce data. UltiProâ€™s document management features can be used to house and categorize employee-related documents such as driversâ€™ licenses, consent forms, and completed I-9s with required identification. Administrators and managers have the ability to attach Microsoft Word documents, PDFs, JPEG files, spreadsheets, or any other file types supported by Microsoft Internet Explorer to employee files. The documents can be grouped and sorted to individual requirements, as necessary.
Employee Self-Service. UltiPro Employee Self-Service gives a customerâ€™s employees immediate security-protected access to view their own paycheck details and benefits summaries, frequently used forms and company information. They can also update personal information such as address, phone number, emergency contacts and skills; change preferences such as direct deposit accounts and benefits selections; make routine requests such as asking for vacation time; and enroll in training.
Administration. UltiPro includes many tools designed to streamline employee administration. Administration features include workflow-based work events, standard reporting, and system administration. Workflow work events features enable users to authorize HR/payroll staff, managers or supervisors to make updates on the Web through more than 100 pre-defined workflow processes to expedite business activities such as hiring an employee or inputting a salary increase. Standard reporting allows authorized managers or HR/payroll staff to run standard UltiPro reports, including upcoming performance reviews, headcount reports, average salary reports, government compliance reports, general ledger reporting, and other point-in-time HR/payroll reports from the Web without requiring the time of central HR/payroll or IT staff. System administration was designed for the non-technical user to administer UltiProâ€™s roles-based security, built-in workflow and system business rules, as well as enable system administrators to post company communications, link to external Web sites from the UltiPro portal, and, through UltiProâ€™s Color Palette feature, select the colors of UltiProâ€™s Web pages to match the customerâ€™s own company image.
Other Key Features. UltiPro also includes tax management to deliver Federal, state and local tax updates automatically every quarter as part of the core solution; Enterprise Integration Tools that provide the ability to interface with third-party applications and providers such as general ledger, tax filing services, time clocks, banks, 401(k) and benefit providers, check printing services and unemployment management services; and disaster recovery services.
UltiPro Add-On Products
UltiPro Add-On Products include, but are not limited to, the following products, which are supplemental to UltiPro Core:
UltiPro Talent Management (â€śUTMâ€ť), is a suite of add-on products comprised of Recruitment, Onboarding, Performance Management, Learning Management and Compensation Management, which are sold individually or as a product suite.
Recruitment. UltiPro Recruitment delivers a â€śone-stop shoppingâ€ť solution for companies to recruit, acquire, and hire the most qualified candidates. By automating the entire recruiting and applicant tracking process, UltiPro Recruitment enables hiring managers, recruiters, and HR staff to track and manage all recruitment tasks such as posting open jobs, reviewing resumes, screening candidates, and scheduling interviews from the central UltiPro portal.
Onboarding. UltiPro Onboarding is a comprehensive Web-based tool that provides employers the ability to automate the process of bringing a new employee into an organization. Employees can be given a â€śwelcomeâ€ť package online as part of a step-by-step process that is built into UltiPro Onboarding and is easily configurable by the customer. It includes such activities as: obtaining required government and procedural paperwork, including electronic signatures and document storage; provisioning necessary equipment and job-specific tools such as office location, computer equipment, uniforms, etc.; ensuring enrollment in necessary training programs; and instilling the companyâ€™s core values and business objectives.
Performance Management. UltiPro Performance Management helps companies maximize talent development and improve employee satisfaction by automating and enhancing the performance process and using competency-based employee development. UltiProâ€™s performance management streamlines the processes of evaluating performance and completing performance reviews, performing competency assessments, identifying top performers for succession planning, and tracking and executing coaching and development plans.
Learning Management. UltiPro Learning Management provides tools designed for organizations to effectively manage employee learning objectives and company training activities. From initial planning and logistics to course and content evaluation, UltiPro facilitates the training registration process, tracks program costs, and records employee training achievements. UltiPro Learning Management brings relevant training options to employee and manager desktops. Employees can view course schedules and descriptions and register online, and managers can approve staff training requests over the Web. UltiPro Learning Management is integrated with UltiProâ€™s Performance Management so that competency-based learning goals can be set during performance evaluation and coaching plans are linked to upcoming training courses to ensure completion.
Compensation Management. UltiProâ€™s Compensation Management programs (including variable pay programs) accommodate pay scales or salary grades, help regulate merit increases to stay on budget, and track and reports on global compensation. UltiPro also provides salary planning and budgeting tools for executives and managers to plan and facilitate annual compensation increases or lump sum bonuses based on assigned percent or dollar allocations eliminating the need for manual reporting and spreadsheet distribution. These tools include workflow review and approval for roll-up and final approval at the executive level.
LeRoy A. Vander Putten has served as a director of the Company since October 1997, is Chairman of the Compensation Committee of the Board and is a member of the Audit Committee of the Board. Mr. Vander Putten is a retired insurance company executive. He served as the Executive Chairman of The Insurance Center, Inc., a holding company for 14 insurance agencies, from October 2001 to January 27, 2006. Previously, he served as the Chairman of CORE Insurance Holdings, Inc., a member of the GE Global Insurance Group, engaged in the underwriting of casualty reinsurance, from August 2000 to August 2001. From April 1998 to August 2000, he served as Chairman of Trade Resources International Holdings, Ltd., a corporation engaged in trade finance for exporters from developing countries. From January 1988 until May 1997, Mr. Vander Putten was Chairman and Chief Executive Officer of Executive Risk Inc., a specialty insurance holding company.
Robert A. Yanover has served as a director of the Company since January 1997 and is Chairman of the Audit Committee and a member of the Compensation Committee of the Board. Mr. Yanover founded Computer Leasing Corporation of Michigan, a private leasing company, in 1975 and served as its President from its founding until 2007 at which time Mr. Yanover retired. Mr. Yanover also founded Lason, Inc., a corporation specializing in the imaging business, and served as Chairman of the Board from its inception in 1987 until 1998 and as a director through February 2001.
MANAGEMENT DISCUSSION FROM LATEST 10K
Ultimate Software designs, markets, implements and supports human resources, payroll and talent management solutions.
Ultimate Softwareâ€™s UltiPro software (â€śUltiProâ€ť) is a comprehensive Web-based solution designed to deliver the functionality businesses need to manage the employee life cycle, from recruiting and hiring to compensating and managing benefits to terminating, whether the customerâ€™s processes are centralized at headquarters or distributed across multiple divisions or branch offices. UltiProâ€™s end-to-end functionality includes comprehensive online recruitment tools, HR and benefits management, a strong payroll engine, time and attendance management, workforce scheduling, on-line benefits enrollment, training management, performance and learning management, reporting and analytical decision-making tools, and a self-service Web portal for executives, managers, administrators, and employees. Ultimate Software believes that UltiPro helps customers streamline HR and payroll processes to significantly reduce administrative and operational costs, while also empowering managers and staff to analyze workforce trends for better decision making, access critical information quickly and perform routine business activities efficiently.
The Companyâ€™s main sources of revenues include sales from the Intersourcing (defined below) offering, sales of perpetual software licenses for UltiPro (and the related annual maintenance) and sales of services (mostly implementation) related to both Intersourcing and license sales.
Since 2002, the Companyâ€™s business strategy has been to sell its UltiPro software offerings primarily on a recurring revenue basis, with perpetual software licenses of UltiPro offered to customers that do not prefer a subscription-based arrangement. The primary focus is to maximize the recurring revenue streams in an effort to minimize the volatility and unpredictable nature of a business strategy predominantly focused on license sales. Prior to 2002, the Companyâ€™s business strategy was centered on sales of perpetual software licenses of UltiPro.
The primary sources of the Companyâ€™s recurring revenue stream are hosting services, branded â€śIntersourcingâ€ť and product maintenance (i.e., software updates and telephone customer support). Other recurring revenue sources include subscription revenues from third-party business service providers (â€śBSPsâ€ť) and recurring revenues from the Original Ceridian Agreement. (See â€śOriginal Ceridian Agreementâ€ť below).
Ultimate Software offers hosting services at two separate data center locations â€“ the original location in the Miami, Florida area, which began operating in 2002, and the second location in the Atlanta, Georgia area, which began operating in August 2005. Both data centers are owned by AT&T. Management of the data centers was provided to the Company by IBM until November 1, 2007 when the Companyâ€™s data center management contract was assigned by IBM to Quality Technology Services (â€śQTSâ€ť). QTS is one of the largest privately held providers of data center facilities and management services in the United States. The Companyâ€™s hardware at the Atlanta data center is scheduled to be moved to a data center owned and operated by QTS in late March 2008. With Intersourcing, Ultimate Software provides the hardware, infrastructure, ongoing maintenance and back-up services for its customers at its data centers in the Atlanta area. Intersourcing is designed to appeal to those customers that want to minimize their internal technology support requirements for the application and hardware.
Since the introduction of its Intersourcing offering in 2002, the revenue mix in the Companyâ€™s sales production has favored Intersourcing. Management believes that this trend in sales mix composition will continue to occur in the foreseeable future, with a concentration of unit sales in Intersourcing. Management also believes the shift in sales mix has helped to produce a more predictable revenue stream by providing recurring revenue and cash from Intersourcing over the related contract periods, typically 24 months. As Intersourcing units are sold, the recurring revenue backlog associated with Intersourcing grows, enhancing the predictability of future revenue streams. Intersourcing sales include a one-time upfront fee, priced on a per-employee basis, and ongoing monthly fees, priced on a per-employee-per-month (â€śPEPMâ€ť) basis. Upfront fees associated with the Intersourcing sale are recognized as recurring subscription revenues ratably over the term of the related contract beginning when the related customer processes its first live payroll (or goes â€śLiveâ€ť). Ongoing monthly PEPM fees are recognized as recurring subscription revenues each month commencing when the related customer goes Live.
In connection with the Companyâ€™s business strategy, an internal financial metric used by the Company in measuring future financial performance is new annual recurring revenues. New annual recurring revenues (â€śARRâ€ť) represent the expected one-year value from (i) new Intersourcing sales from the Companyâ€™s hosted model (including prorated one-time fees); (ii) maintenance revenues related to new license sales; and (iii) recurring revenues from additional sales to Ultimate Softwareâ€™s existing client base. New annual recurring revenues attributable to sales during 2007 were $31.1 million as compared to $24.5 million for 2006. The main contributors to the increase in new ARR were new sales from the Companyâ€™s Intersourcing Offering (including prorated one-time fees, and add-on products) and, to a lesser extent, an increase in annual recurring maintenance revenues related to new license sales.
Original Ceridian Agreement
As previously disclosed, Ultimate Software and Ceridian Corporation (â€śCeridianâ€ť) signed an agreement in 2001, as amended, granting Ceridian a non-exclusive license to use UltiPro software as part of an on-line offering for Ceridian to market primarily to businesses with less than 500 employees (the â€śOriginal Ceridian Agreementâ€ť). Ceridian marketed that solution under the name Source Web. During December 2004, RSM McGladrey Employer Services (â€śRSMâ€ť), a BSP of Ultimate Software, acquired Ceridianâ€™s Source Web HR/payroll and self-service product and existing Source Web base of small and mid-size business customers throughout the United States (the â€śRSM Acquisitionâ€ť). The financial terms of the Original Ceridian Agreement were not changed as a result of the RSM Acquisition. Subsequent to the RSM Acquisition, Ceridian continued to be financially obligated to pay, and did pay, Ultimate Software minimum fees pursuant to the terms of the Original Ceridian Agreement.
The aggregate minimum payments that Ceridian was obligated to pay Ultimate Software under the Original Ceridian Agreement over the minimum term of the agreement are $42.7 million. To date, Ceridian has paid to Ultimate Software a total of $42.1 million under the Original Ceridian Agreement. Ultimate Software expects to continue to recognize a minimum of $642,000 per month in subscription revenues (a component of recurring revenues) from the Original Ceridian Agreement until its termination date. The amount of subscription revenues recognized under the Original Ceridian Agreement during the year ended December 31, 2007, totaling $7.7 million, was the same as those recognized in 2006 and 2005. Effective March 9, 2006, Ceridian provided Ultimate Software with a two yearsâ€™ advance written notice of termination of the Original Ceridian Agreement, as permitted under the terms of the Agreement. Pursuant to such notice, the Original Ceridian Agreement terminated on March 9, 2008.
Critical Accounting Estimates
The preparation of financial statements in conformity with U.S. generally accepted accounting principles in the United States (â€śGAAPâ€ť) requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
Sources of revenue for the Company include:
â€˘ Sales of the right to use UltiPro through Intersourcing (the â€śIntersourcing Offeringâ€ť), which includes Hosting Services (defined below);
â€˘ Sales of services to host the UltiPro application (â€śHosting Servicesâ€ť) in conjunction with sales of perpetual licenses of UltiPro;
â€˘ Sales of Hosting Services on a stand-alone basis to customers who already own a perpetual license (â€śBase Hostingâ€ť);
â€˘ Recurring revenues derived from (1) maintenance revenues generated from maintaining, supporting and providing periodic updates for the Companyâ€™s products under software license agreements and (2) subscription revenues generated from per employee per month (â€śPEPMâ€ť) fees earned through the Intersourcing Offering and Base Hosting, amortization of Intersourcing or Hosting Servicesâ€™ one-time fees, revenues generated from the Original Ceridian Agreement and, to a lesser extent, PEPM fees from sales of BSPs;
â€˘ Sales of perpetual licenses for UltiPro; and
â€˘ Sales of services including implementation, training (also known as knowledge management) and other services, including the provision of payroll-related forms and the printing of Form W-2â€™s for certain customers, as well as services provided to BSPs.
Sales Generated from the Intersourcing Offering
Subscription revenues generated from the Intersourcing Offering are recognized in accordance with Emerging Issues Task Force (â€śEITFâ€ť) No. 00-21, â€śRevenue Arrangements with Multiple Deliverablesâ€ť (â€śEITF No. 00-21â€ť) as a services arrangement since the customer is purchasing the right to use UltiPro rather than licensing the software on a perpetual basis. Fair value of multiple elements in Intersourcing arrangements is assigned to each element based on the guidance provided by EITF No. 00-21.
The elements that typically exist in Intersourcing arrangements include Hosting Services, the right to use UltiPro, maintenance of UltiPro (i.e., product enhancements and customer support) and professional services (i.e., implementation services and training in the use of UltiPro). The pricing for Hosting Services, the right to use UltiPro and maintenance of UltiPro is bundled (the â€śBundled Elementsâ€ť). Since these three Bundled Elements are components of recurring revenues in the consolidated statements of income, allocation of fair values to each of the three elements is not necessary and they are not reported separately. Fair value for the Bundled Elements, as a whole, is based upon evidence provided by the Companyâ€™s pricing for Intersourcing arrangements sold separately. The Bundled Elements are provided on an ongoing basis and represent undelivered elements under EITF No. 00-21; they are recognized on a monthly basis as the services are performed, once the customer processes its first live payroll (i.e., goes â€śLiveâ€ť).
Implementation and training services (the â€śProfessional Servicesâ€ť) provided for Intersourcing arrangements are typically priced on a time and materials basis and are recognized as services revenue in the consolidated statements of income as the services are performed. Under EITF 00-21, fair value is assigned to service elements in the arrangement based on their relative fair values, using the prices established when the services are sold on a stand-alone basis. Fair value for Professional Services is based on the respective Implementation Valuation (defined below) and Training Valuation (defined below). If evidence of the fair value of one or more undelivered elements does not exist, the revenue is deferred and recognized when delivery of those elements occurs or when fair value can be established.
The Company believes that applying EITF 00-21 to Intersourcing arrangements as opposed to applying SOP 97-2 is appropriate given the nature of the arrangements whereby the customer has no right to the UltiPro license.
Sales of Base Hosting Services
Subscription revenues generated from Base Hosting are recognized in accordance with EITF No. 00-3, â€śApplication of AICPA Statement of Position 97-2 to Arrangements that Include the Right to Use Software Stored on Another Entityâ€™s Hardware,â€ť which provides guidance as to the application of SOP 97-2 to hosting arrangements that include a license right to the software. The elements that typically exist for Base Hosting arrangements include Hosting Services and implementation services. Base Hosting is different than Intersourcing arrangements in that the customer already owns a perpetual license and is subsequently adding Hosting Services or is purchasing a perpetual license for UltiPro together with Hosting Services, whereas, with Intersourcing, the customer is purchasing the right to use (not license) UltiPro together with Hosting Services. Implementation services provided for Base Hosting arrangements, whereby the customer already owns a perpetual license, are less than those provided for Intersourcing arrangements since UltiPro is already implemented in these Base Hosting arrangements and only needs to be transitioned to a hosted environment. Fair value for Hosting Services is based on the Hosting Valuation (defined below). The fair value for implementation services is based on the Implementation Valuation in accordance with guidelines provided by SOP 97-2.
Recurring revenues include maintenance revenues and subscription revenues. Maintenance revenues are derived from maintaining, supporting and providing periodic updates for the Companyâ€™s software. Subscription revenues are principally derived from PEPM fees earned through the Intersourcing Offering, Base Hosting and the BSP sales channel, as well as revenues generated from the Original Ceridian Agreement. Maintenance revenues are recognized ratably over the service period, generally one year. Maintenance and support fees are generally priced as a percentage of the initial license fee for the underlying products.
To the extent there are upfront fees associated with the Intersourcing Offering, Base Hosting or the business service providers (or â€śBSPâ€ť) sales channel, subscription revenues are recognized ratably over the minimum term of the related contract upon the delivery of the product and services. In the cases of Intersourcing and Base Hosting sales, amortization of the upfront fees commences when the customer processes its first Live payroll, which typically occurs four to six months after the sale, and extends until the end of the initial contract period. In the case of BSP channel sales, amortization of the upfront fee typically commences when the contract is signed, which is when the BSPâ€™s rights under the agreement begin, continuing until the initial contract term ends. Ongoing PEPM fees from the Intersourcing Offering, Base Hosting and the BSP sales channel are recognized as subscription revenue as the services are delivered, typically on a monthly basis.
As discussed above, subscription revenues from the Original Ceridian Agreement of $642,000 per month were recognized in each of the three years ended December 31, 2007 and are expected to be recognized until the expiration of such agreement on March 9, 2008.
Maintenance services provided to customers include product updates and technical support services. Product updates are included in general releases to the Companyâ€™s customers and are distributed on a periodic basis. Such updates may include, but are not limited to, product enhancements, payroll tax updates, additional security features or bug fixes. All features provided in general releases are unspecified upgrade rights. To the extent specified upgrade rights or entitlements to future products are included in a multi-element arrangement, revenue is recognized upon delivery provided fair value for the elements exists. In multi-element arrangements that include a specified upgrade right or entitlement to a future product, if fair value does not exist for all undelivered elements, revenue for the entire arrangement is deferred until all elements are delivered or when fair value can be established.
Subscription revenues generated from the BSP sales channel include both the right to use UltiPro and maintenance. The BSP is charged a fee on a PEPM basis. Revenue is recognized on a PEPM basis as the services are provided to the underlying customer. To the extent the BSP pays the Company a one-time upfront fee, the Company accounts for such fee by recognizing it as subscription revenue over the minimum term of the related agreement.
Sales of Perpetual Licenses for UltiPro Sold With or Without Hosting Services
Sales of perpetual licenses for UltiPro and sales of perpetual licenses for UltiPro in conjunction with Hosting Services are multiple-element arrangements that involve the sale of software and consequently fall under the guidance of Statement of Position (â€śSOPâ€ť) 97-2, â€śSoftware Revenue Recognition,â€ť for revenue recognition.
The Company licenses software under non-cancelable license agreements and provides services including maintenance, implementation consulting and training services. In accordance with the provisions of SOP 97-2, license revenues are generally recognized when (1) a non-cancelable license agreement has been signed by both parties, (2) the product has been shipped, (3) no significant vendor obligations remain and (4) collection of the related receivable is considered probable. To the extent any one of these four criteria is not satisfied, license revenue is deferred and not recognized in the audited consolidated statements of income until all such criteria are met.
For multiple-element software arrangements, each element of the arrangement is analyzed and the Company allocates a portion of the total fee under the arrangement to the elements based on vendor-specific objective evidence of fair value of the element (â€śVSOEâ€ť), regardless of any separate prices stated within the contract for each element. Fair value is considered the price a customer would be required to pay when the element is sold separately.
The Residual Method (as defined below) is used to recognize revenue when a license agreement includes one or more elements to be delivered at a future date and VSOE of the fair value of all undelivered elements exists. The fair value of the undelivered elements is determined based on the historical evidence of stand-alone sales of these elements to customers. Undelivered elements in a license arrangement typically include maintenance, implementation and training services (the â€śStandard Undelivered Elementsâ€ť). The fair value for maintenance fees is based on the price of the services sold separately, which is determined by the annual renewal rate historically and consistently charged to customers (the â€śMaintenance Valuationâ€ť). Maintenance fees are generally priced as a percentage of the related license fee. The fair value for implementation services is based on standard pricing (i.e., rate per hour charged to customers for implementation services), for stand-alone sales of implementation services (the â€śImplementation Valuationâ€ť). The fair value for training services is based on standard pricing (i.e., rate per training day charged to customers for class attendance), taking into consideration stand-alone sales of training services through year-end seminars and historically consistent pricing for such services (the â€śTraining Valuationâ€ť). Under the residual method (the â€śResidual Methodâ€ť), the fair value of the undelivered elements is deferred and the remaining portion of the arrangement fee attributable to the delivered element, the license fee, is recognized as license revenue. If VSOE for one or more undelivered elements does not exist, the revenue is deferred on the entire arrangement until the earlier of the point at which (i) such VSOE does exist or (ii) all elements of the arrangement have been delivered.
MANAGEMENT DISCUSSION FOR LATEST QUARTER
Results of Operations
The Companyâ€™s revenues are derived from three principal sources: recurring revenues, services revenues and software licenses (â€ślicense revenuesâ€ť).
Recurring revenues consist of maintenance revenues, Intersourcing revenues from the Companyâ€™s hosted offering of UltiPro and subscription revenues from per-employee-per-month (â€śPEPMâ€ť) fees generated by BSPâ€™s, principally Ceridian. Maintenance revenues are derived from maintaining, supporting and providing periodic updates for the Companyâ€™s products under software license agreements. Subscription revenues are principally derived from PEPM fees earned through the Intersourcing Offering, Base Hosting and revenues generated from the Original Ceridian Agreement. Maintenance revenues are recognized ratably over the service period, generally one year. To the extent there are upfront fees associated with the Intersourcing Offering or Base Hosting, subscription revenues are recognized ratably over the minimum term of the related contract upon the delivery of the product and services. Ongoing PEPM fees from the Intersourcing Offering and Base Hosting are recognized as subscription revenues (a component of recurring revenues in the unaudited condensed consolidated statements of operations) as the services are delivered.
Services revenues include revenues from fees charged for the implementation of the Companyâ€™s software products and training of customers in the use of such products, fees for other services, including the provision of payroll-related forms and the printing of Form W-2â€™s for certain customers and certain reimbursable out-of-pocket expenses. Revenues for training and implementation consulting services are recognized as services are performed to the extent the pricing for such services is on a time and materials basis. Other services are recognized as the product is shipped or as the services are rendered, depending on the specific terms of the arrangement.
Arrangement fees related to fixed-fee implementation services contracts are recognized using the percentage of completion accounting method, which involves the use of estimates. Percentage of completion is measured at each reporting date based on hours incurred to date compared to total estimated hours to complete the implementation job. If a sufficient basis to measure the progress towards completion does not exist, revenue is recognized when the project is completed or when the Company receives final acceptance from the customer.
License revenues include revenues from software license agreements for the Companyâ€™s products, entered into between the Company and its customers in which the license fees are non-cancelable. License revenues are generally recognized upon the delivery of the related software product when all significant contractual obligations have been satisfied. Until such delivery, the Company records amounts received when contracts are signed as customer deposits which are included with deferred revenues in the unaudited condensed consolidated balance sheets.
Total revenues, consisting of recurring, services and license revenues, increased 31.4% to $37.8 million for the three months ended September 30, 2007 from $28.8 million for the three months ended September 30, 2006, and 33.7% to $109.3 million for the nine months ended September 30, 2007 from $81.8 million for the nine months ended September 30, 2006.
Recurring revenues increased 34.5% to $22.2 million for the three months ended September 30, 2007 and 35.0% to $62.7 million for the nine months ended September 30, 2007. The increases in recurring revenues for the three and nine months ended September 30, 2007 were primarily due to increases in Intersourcing revenues and, to a lesser extent, maintenance revenues.
a) Intersourcing revenues increased primarily due to the continued growth of the Intersourcing offering, which comprises the majority of unit sales. The increase is based on the revenue impact of incremental units that have gone â€śliveâ€ť (i.e., when the underlying customer processes its first live payroll for its employees) since September 30, 2006. Recognition of recurring revenues for Intersourcing unit sales commences upon â€śliveâ€ť date.
b) Maintenance revenues increased due to additional maintenance fees resulting from cumulative increases in the customer base subsequent to September 30, 2006 due to incremental license sales since such date. Maintenance revenues are recognized over the initial term of the related license contract, which is typically 12 months, and then on a recurring basis thereafter (on a monthly basis ratably over the term of the respective renewal period).
c) Recurring subscription revenues recognized for the three and nine months ended September 30, 2007 from the Original Ceridian Agreement, totaling $1.9 million and $5.8 million, respectively, were the same as those recognized during the same periods of the prior year. Beginning on August 28, 2002, subscription revenues generated from the Original Ceridian Agreement of $642,000 per month have been recognized, and are expected to be recognized, over the minimum term of the contract expiring in March 2008.
d) The impact on recurring revenues of units sold under the Intersourcing Offering (as compared to the impact on license revenues of licensed units sold) is expected to be a gradual increase from one period to the next, based on the revenue recognition of the Intersourcing fees over the terms of the related contracts.
Services revenues increased 30.8% to $12.3 million for the three months ended September 30, 2007 and 37.7% to $35.8 million for the nine months ended September 30, 2007. The increases in the three- and nine-month periods were mainly due to an increase in implementation revenues. The increase in implementation revenues was principally due to additional billable hours, stemming from an increase in the number of revenue-generating consultants and incremental units sold. In addition, the Company used third-party implementation partners more in the nine months ended September 30, 2007 than during the comparable period of the prior year to assist in handling the increased demand for implementations due to increased sales, which also contributed to the growth in services revenues.
License revenues increased 15.8% to $3.3 million for the three months ended September 30, 2007 and 15.9% to $10.8 million for the nine months ended September 30, 2007. The increases in the three and nine months ended September 30, 2007 were principally due to a larger number of new units sold by the Companyâ€™s direct sales force (particularly in the first quarter of 2007 with respect to the nine-month comparison), a higher average selling price per unit and, to a lesser extent, increased sales to existing clients.
Cost of Revenues
Cost of revenues consists of the cost of recurring, services and license revenues. Cost of recurring revenues consists of costs to provide maintenance and technical support to the Companyâ€™s customers, the cost of providing periodic updates and the cost of subscription revenues, including amortization of capitalized software. Cost of services revenues primarily consists of costs to provide implementation services and training to the Companyâ€™s customers and, to a lesser degree, costs related to sales of payroll-related forms and costs associated with certain reimbursable out-of-pocket expenses, discussed below. Cost of license revenues primarily consists of fees payable to third-parties for software products distributed by the Company. UltiPro includes third-party software for enhanced report writing purposes and for time and attendance functionality. The Company pays a license fee to a third-party provider for report writing software used in conjunction with UltiPro. When UltiPro licenses are sold with the add-on time and attendance product introduced in 2006, referred to as Ultimate Time and Attendance (â€śUTAâ€ť), customers pay the Company on a per user basis for the license rights to such third-party software.
Total cost of revenues (including $0.5 million and $1.7 million in stock-based compensation for the three and nine months ended September 30, 2007, respectively, as compared to $0.2 million and $0.9 million for the three and nine months ended September 30, 2006, respectively) increased 31.5% to $16.0 million for the three months ended September 30, 2007 and 35.8% to $47.1 million for the nine months ended September 30, 2007.
Cost of recurring revenues increased 22.3% to $5.6 million for the three months ended September 30, 2007 and 27.4% to $16.6 million for the nine months ended September 30, 2007. The increases in cost of recurring revenues for the three and nine months ended September 30, 2007 (which included stock-based compensation of $0.2 million and $0.5 million for the three and nine months ended September 30, 2007, respectively, as compared to $0.1 million and $0.3 million for the three and nine months ended September 30, 2006, respectively) was primarily due to the increases in both Intersourcing costs and maintenance costs. The increase in the Intersourcing costs was principally due to the growth in Intersourcing operations and increased sales, including increased labor costs and higher operating costs such as depreciation and amortization of related computer equipment supporting the operations and costs associated with the operations of the Companyâ€™s two data centers. The increase in maintenance costs was primarily related to increased labor costs commensurate with the growth in the number of customers serviced.
Cost of services revenues increased 38.1% to $10.1 million for the three months ended September 30, 2007 and 42.5% to $29.4 million for the nine months ended September 30, 2007. The increases in cost of services revenues for the three and nine month periods ended September 30, 2007 (which included stock-based compensation of $0.3 million and $1.2 million for the three and nine months ended September 30, 2007 as compared to $0.2 million and $0.6 million for the three and nine months ended September 30, 2006, respectively), was primarily due to an increase in costs of implementation. Due to the continued sales growth of both Intersourcing and license units, there was an increase in labor costs primarily resulting from additional billable consultants hired since September 30, 2006 to support this growth. Also impacting the increase in implementation costs for the nine-month period was the increased use of third-party implementation partners who assisted in handling the increased demand for implementing UltiPro and add-on products.
Cost of license revenues increased 10.3% to $352 thousand for the three months ended September 30, 2007 and 6.2% to $1.0 million for the nine months ended September 30, 2007. The slight increases in cost of license revenues for the three and nine months ended September 30, 2007 as compared to the same period in 2006 was consistent with the increased license revenues during the three and nine months ended September 30, 2007.
S ales and Marketing
Sales and marketing expenses consist primarily of salaries and benefits, sales commissions, travel and promotional expenses, and facility and communication costs for direct sales offices, as well as advertising and marketing costs. Sales and marketing expenses increased 25.2% to $9.0 million for the three months ended September 30, 2007 and 21.0% to $26.3 million for the nine months ended September 30, 2007. The increases in sales and marketing expenses for the three and nine month periods ended September 30, 2007 were primarily due to increased labor and related costs (including $1.2 million and $3.3 million of stock-based compensation for the three and nine months ended September 30, 2007, respectively, compared to $0.8 million and $2.0 million of stock-based compensation for the three and nine months ended September 30, 2006, respectively), attributable to hiring additional direct sales force personnel for the sales organization and higher sales commissions principally related to increased Intersourcing and license sales. Commissions on license sales are recognized when the license revenues are recognized, which is typically when the product is shipped. Commissions on Intersourcing sales are amortized over the initial contract term (typically 24 months) commencing on â€śliveâ€ť date, which corresponds to Intersourcing revenue recognition.
Research and Development
Research and development expenses consist primarily of software development personnel costs. Research and development expenses increased 20.7% to $7.1 million for the three months ended September 30, 2007 and 26.7% to $20.9 million for the nine months ended September 30, 2007. Excluding the impact of capitalized costs associated with UltiPro Canada, which totaled $0.5 million and $1.4 million for the three and nine month periods ended September 30, 2007, respectively, research and development expenses increased by $1.2 million and $4.5 million for the three and nine months ended September 30, 2007, respectively, in comparison to the same periods last year, principally due to higher labor costs, including the impact of increased staffing related to the ongoing development of UltiPro and add-on products, as well as annual merit increases and, to a lesser extent, $0.2 million and $0.8 million of stock-based compensation expense for the three and nine month periods ended September 30, 2007, respectively, as compared to $0.1 million and $0.4 million for the three and nine month periods ended September 30, 2006, respectively.
In accordance with SFAS No. 86, â€śAccounting for the Costs of Computer Software to be Sold, Leased or Otherwise Marketedâ€ť (â€śSFAS No. 86â€ť), the Company capitalized certain research and development personnel costs for the development of UltiPro Canada functionality. UltiPro Canada is being built from the existing product infrastructure of UltiPro (e.g., using UltiProâ€™s source code and architecture). UltiPro Canada is designed to provide HR/payroll functionality which includes the availability of Canadian tax rules, as well as Canadian human resources functionality, taking into consideration labor laws in Canada and including changes to the language where necessary (i.e., English to French). The Company expects to capitalize additional research and development costs relative to the UltiPro Canada project until its anticipated general release, which is expected to occur in the last quarter of 2007, at which time capitalization would cease under SFAS No. 86 guidelines.
General and Administrative
General and administrative expenses consist primarily of salaries and benefits of executive, administrative and financial personnel, as well as external professional fees and the provision for doubtful accounts. General and administrative expenses for the three months ended September 30, 2007 increased 44.3% to $3.6 million and 37.5% to $10.3 million for the nine months ended September 30, 2007. The increases for the three and nine months ended September 30, 2007 were primarily due to additional labor costs (including additional personnel costs to support the Companyâ€™s growth) and an increase in the provision for doubtful accounts. Included in general and administrative expenses for the three and nine month periods ended September 30, 2007 were $0.7 million and $1.5 million, respectively, of stock-based compensation expense as compared to $0.3 million and $0.8 million for the three and nine months ended September 30, 2006, respectively, and $0.1 million and $0.2 million of amortization of acquired intangible assets for the three- and nine-month period ended September 30, 2007, respectively. There was no amortization of acquired intangible assets for the same periods in the prior year.
Interest expense of $61 thousand and $161 thousand for the three and nine months ended September 30, 2007, respectively, was comparable to interest expense during the same period in the prior year.
Other Income, Net
Other income, net, for the three months ended September 30, 2007 was comparable to other income, net for the three months ended September 30, 2006 and increased to $5.6 million for the nine months ended September 30, 2007 from $1.1 million for the nine months ended September 30, 2006. Included in other income, net, in the unaudited condensed consolidated statement of operations for the nine months ended September 30, 2007 is a non-recurring settlement fee of $4.4 million, net of related costs, resulting from the early termination of a multi-year business arrangement with one of our business partners that decided to exit the payroll business (the â€śNon-Recurring Settlementâ€ť).
For the three months ended September 30, 2007, there was no income tax provision and for the nine months ended September 30, 2007, there was an income tax provision of $115 thousand. There was no such provision for the same periods in the prior year. We assess the likelihood that we will be able to recover our deferred tax assets. We consider all available evidence, both positive and negative, including historical levels of income, expectations and risk associated with estimates of future taxable income, ongoing, prudent and feasible tax planning strategies in assessing the amount of the valuation allowance. If recovery is not more likely than not, we record a valuation allowance against the deferred tax assets that we estimate will not ultimately be recoverable.
The Companyâ€™s net operating loss carryforwards available at December 31, 2006, which expire at various times through the year 2026 and that are available to offset future taxable income, were $74.4 million. The timing and levels of future profitability may result in the expiration of net operating loss carryforwards before utilization. Additionally, utilization of such net operating losses may be limited as a result of cumulative ownership changes in the Companyâ€™s equity instruments.
Liquidity and Capital Resources
The Company funds operations primarily through the private and public sale of equity securities, cash generated from operations and, to a lesser extent, equipment financing and borrowing arrangements.
As of September 30, 2007, the Company had $32.2 million in cash, cash equivalents and total investments in marketable securities, reflecting a net decrease of $0.8 million since December 31, 2006. The $0.8 million decrease was primarily due to repurchases of Common Stock under the Companyâ€™s stock repurchase plan of $19.0 million and an increase in capital expenditures of $6.9 million (including cash purchases of property, equipment and payments on financed equipment, including capital lease obligations), partially offset by cash generated from operations of $20.4 million (including $4.5 million in cash received for the Non-Recurring Settlement) and cash provided from employee stock option exercises totaling $6.1 million.
Net cash provided by operating activities was $20.4 million for the nine months ended September 30, 2007 as compared to $10.3 million for the nine months ended September 30, 2006. The $10.1 million increase in net cash provided by operating activities was primarily due to increased funds generated from operations which included receipt of the settlement fee from the Non-Recurring Settlement, as well as the Companyâ€™s increase in sales, including both increased sales of Intersourcing units and license units.
Net cash used in investing activities was $6.2 million for the nine months ended September 30, 2007 as compared to $8.5 million for the nine months ended September 30, 2006. The $2.3 million decrease in net cash used in investing activities was primarily due to a net decrease in cash purchases of marketable securities of $2.5 million.
Net cash used in financing activities was $15.0 million for the nine months ended September 30, 2007 as compared to $5.2 million for the nine months ended September 30, 2006. The $9.8 million increase in net cash used in financing activities was primarily related to a $9.2 million increase in repurchases of Common Stock pursuant to the Companyâ€™s stock repurchase plan.
Days sales outstanding, calculated on a trailing three-month basis (â€śDSOâ€ť), as of September 30, 2007 and 2006, were 71 days and 66 days, respectively. The increase in DSOâ€™s as of September 30, 2007 was related to the increase in accounts receivable principally from incremental revenues generated.
Mitchell K. Dauerman
Thank you, Dustin. 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 will be making other forward-looking statements regarding our current expectations of 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 at www.sec.gov 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 statements, whether as a result of new information, future events or otherwise.
I'm going to discuss the financial results for our third quarter of 2008. Unless otherwise noted, our discussion will be on a non-GAAP basis for all costs, gross margins, net income, and EPS, when comparing to the same period in the prior year. The primary difference between GAAP and non-GAAP financial information is non-cash stock-based compensation.
Please refer to the reconciliation of the financial information on a GAAP basis to that on a non-GAAP basis attached to the press release published on our website.
Based upon our revised guidance from last quarter, I'm going to focus my comments on our third quarter performance relative to our revised forecast, our fourth quarter guidance, and our look for 2009.
New ARR for the third quarter was $10.8 million, a 51% increase over the same quarter last year, and a 46% year-to-date growth for the comparable 9 month periods. Workplace sales contributed 19% of the new ARR for the quarter.
For Q3, our recurring revenues were $26.7 million, coming in slightly above our expectation. The new time to live period for our intersourcing sales discussed last quarter remained in line with our expectations. The attrition rate for our intersourcing customers stayed consistent with Q2 at a 3% annualized rate.
Service revenues for Q3 were in line with our revised expectations; however, the composition within service revenues was different than we anticipated. Our implantation revenues were higher than expected, because we made a decision to bring in third party implementation partners to help clear the backlog, which we discussed last quarter. This third party program will continue into Q4.
We also began to experience pressure on our standard time and material hourly billing rate as compared to our expectations. Partially offsetting this increase in implementation revenues were training revenues and forms revenues which were lower than expected. On the training revenue side, we experienced some class cancellations due to the hurricanes that hit the country during this quarter.
We noticed clients deciding to send fewer participants to class, as well as fewer clients requesting onsite training. On the forms side, we've always been advocates for going paperless, and it appears that clients began going green more so in Q3 than in the past, saving them time and money associated with printing and distributing checks. License revenues came in $2 million less than our expectation.
From a business perspective, the shift of these sales into inter-sourcing will produce a much higher financial return over time. It appears that the uncertainty of the economy is impacting a customer's likelihood of purchasing licensed software when they experience higher up-front costs when compared to subscription-based offerings.
We experienced this change back in 2000. We did not have a defense then to solve the financial problem, but now we do â€“ intersourcing.
Turning to the cost of revenue and gross margin side of our Q3 results, recurring revenue costs were approximately $300,000 over our expectations. These were mostly attributable to higher data center costs.
Last quarter, we successfully moved our Atlanta-based data center, and this quarter we successfully moved our Miami-based data center. The moves were substantial and were necessary to handle the growth in our intersourcing business. We found opportunities during the moves to provide higher levels of service to our customers and after both moves were completed, the result was higher data center costs than we had expected.
Service costs in Q3 were impacted by the additional third party implementation partners used, and, to a lesser extent, bringing on additional billable consultants to handle the higher than expected sales production.
Turning to the operating expense side, research and development expenses were $300,000 above our expectations, mainly because we ended up capitalizing less development costs than we had originally expected.
Sales and marketing expenses exceeded our previous expectation, as we incurred higher advertising and marketing expenses, as well as certain higher labor costs relating to an investment in a new strategic customer relationship program geared towards our growing larger customer base, which Scott will discuss further.
Finally, G&A costs were higher than we expected for Q3, because we increased our allowance for doubtful accounts as a cautionary measure tied to the current uncertain economic environment. As usual, we will continue to monitor our reserve needs for accounts receivable as we go forward.
Okay, next I'd like to discuss our guidance for Q4. The continued success in selling new business gives us confidence in achieving or exceeding our 2008 guidance of 30% growth in ARR for the year.
We expect our recurring revenues to be between $28 million and $29 million, taking into account reduced annual maintenance revenues as they relate to lower license sales, as well as adjusting our employee growth and attrition assumptions for our recurring revenue customers.
Our service revenues are expected to be between $18 million and $19 million after taking into account a $5 lower than expected rate per hour, the continued use of implementation partners, and lower expectations for both training and forms revenues.
We are forecasting license revenues of $2 million for Q4, which are down from our prior estimate of $4.3 million. Gross margins for recurring revenues should be approximately 72%, and service margins should be 20%.
Research and development expenses for Q4 should be around $8.4 million. The reduction from Q3 is due to the fact that the third party contract labor used in Q3 met their deliverables in Q3, and therefore, is not expected to return in Q4. This accounts for about a $500,000 decrease in Q4.
Second, the typical reduction in compensation expense for unused vacation time that cannot be carried forward to the next year and is therefore written off at year-end, accounts for about $200,000 of the expected decrease and, the planned reduction in internal training from Q3 to Q4 primarily represents the balance of the decrease.
All in all, our total R&D expenses for Q3 and Q4 combined should be just slightly above our expectations set in July. For the fourth quarter, sales and marketing costs are expected to be $9.6 million. The reduction from Q3 is mostly due to the fact that we incurred costs for the national sales meeting and midyear club expenses in Q3 which do not recur in Q4, as well as lower commission expense tied to the lower than expected licenses forecasted for Q4.
Our combined Q3 and Q4 sales and marketing expenses should be just slightly above our previous expectation. For the fourth quarter, we expect G&A costs to be around $3.3 million. We should produce operating margins of 9% to 10% in Q4, and I'd note the reduction in the â€“ in our estimated license sales accounts for about a 3% reduction in the overall operating margin for the fourth quarter.
We expect capital expenditures to be around $3 million, and diluted weighted average share count to be 26.5 million shares. Before turning to 2009 guidance, I'd like to compare in a summary way our expectations for the second half of 2008 to the prior guidance we provided in July.
In our model, the total operating income changes by $6.5 million. Of this, $4 million is attributable to lower license revenues, which are offset by higher ARR from intersourcing that we see as a positive for our business going forward. Approximately $1.5 million is due to several things connected with services.
First, there's an increase in the use of implementation partners. Second was the $5 lower than expected services rate per hour, and third were lower training revenues. The remainder is due to higher than expected hosting costs in connection with the two data centers, and other operating costs associated with higher than expected sales growth.
For 2009, our preliminary view for new ARR growth stays at 30%, as we continue to build out our Workplace sales team during the next year. License revenues are estimated at $2 million per quarter, or $8 million for the year, versus $15 million previously expected.
Recurring revenue growth is 30% to 31%, after taking into consideration both the lower maintenance revenues as a result of lower license sales, and adjustments to customers, employment growth, attrition and price increases in our financial model in response to recent economic times.
Total revenues should grow between 22% and 23%. We expect our operating expense growth rate to be between 11% and 12%, as we expect to leverage the R&D investment we made in 2008 during 2009. Recall, we incurred significant third party costs for R&D during 2008 which are not planned to repeat in 2009.
Operating margins of 10% to 12% should be produced for 2009. Consistent with the fourth quarter, the reduction in our license revenues expectations resulted in a 3% reduction in the overall margin. We expect the capital expenditures will be about $13 million, and diluted weighted average shares should be approximately 26.5 million shares.
Turning to our upcoming conference schedule, during the next quarter on December 4th, we will be at the JP Morgan 10th Annual SMid Conference, and on January 6th, we will be at the Needham 11th Annual Growth Stock Conference. Both conferences are held in New York. If you're available at those conferences to meet, please let us know, and now I'd like to turn the call over to Scott.
Thanks, Mitch, and thank you to everyone participating in our call this evening. I'd like to start out by talking about sales. We had a great third quarter. New ARR, annual recurring revenues, are the best indicator of our sales performance, and they were $10.8 million, representing a 51% growth over last year's third quarter ARR. That makes our year-to-date growth in new ARR 46%.
Another metric that reflects our continuing success is the increase in our number of new units. Unit growth for the quarter was up 48% over those in 2007's Q3. Year-to-date unit growth is up 38% as of September 30th.
Our Enterprise team finished Q3 at 103% of planned and they are now 106% of planned year-to-date. They continue to deliver a task rate in line with previous quarters, and 70% of the team are at or above quota as of third quarter close.
An important point about the new business they brought in is that 50% of the new ARR in the third quarter was attributable to companies with more than 3,000 employees. This is consistent with the 49% in new ARR we saw in the second quarter this year from the large-sized Enterprise companies.
Our Workplace team finished the quarter strong as well at 112% of planned. Year-to-date, that makes them 124% of planned. 70% of the Workplace salespeople are above quota, and they contributed 19% of the new ARR for the third quarter this year.
To give you a little more color on their new business, the average size of the new Workplace customer for Q3 was 350 employees and the attach rates were very high. The attach rate for tax filing was 100%. For performance management, it was 86%. For recruitment, 60%, and for time management, 37%, and this was the first full quarter that we offered time management to the market.
These attach rates pushed the average per-employee per-month rate for the new Workplace customer to $14.50. Our plan for expanding market penetration through UltiPro Workplace is obviously working.
We are giving smaller businesses access to an integrated complete talent management suite beyond core HR and payroll, and they clearly see the value. For the first time, they are getting the same kind of advantages that larger companies have for managing their people effectively and efficiently.
To sum up where we are with sales, we are well-positioned for a strong close to 2008. Both teams continue to have very healthy pipelines, and many deals are already in the contract process. We are aware of the current economic environment, and our teams are working harder than ever to prove our value proposition.
We had our all-team meetings earlier this month, and both teams are exceptionally confident and enthusiastic. I want to point out that both our Enterprise and Workplace teams are currently staffed to a level very capable of growing new ARR in 2009 by more than 30%. Now, I'm going to turn to our customer support area and our client base. We maintained our industry-leading 97% customer retention rate in the third quarter. We also analyzed our customers' employee growth and attrition numbers looking at our existing customer base, starting in January of 2008, and tracking them through the end of September 2008.
We found that the average employee count of the consolidated group grew by 1%. In the same analysis, we also found that 53% of our client companies grew in employee size for the first 9 months of 2008. The bottom line is that we now have more than 900,000 employees live in our intersourcing environment.
We achieved our goal of 99.9% uptime in the third quarter, and we maintained our 97% customer retention rate as I mentioned earlier. At the same time, in response to our continued success in selling companies with larger employee populations, we have created and staffed a new strategic client relationship management program for our larger customers that complement our standard client relationship service set.
Our goal, as always, is to strive beyond our best to define a new and better model for excellence in order to set the bar still higher for customer value and satisfaction. In closing, I want to talk about growth and head count.
As of September 30th, we had 908 associates. We had 63 new hires in Q3. 51 of those 63 were directly related to higher sales numbers. Our original 2008 plan was to grow new ARR by 25%. Year-to-date, we have achieved 46%. With that better-than-projected-per formance has become a requirement for more infrastructures.
It is clearly a high priority to get all the new Enterprise and Workplace customers live on core HR and payroll, as well as all the additional products they have bought, and to recognize that revenue as soon as possible. To do that, we had to hire more people. We are not investing ahead of sales; we are investing because of sales.
Our business is stronger than it has ever been before, and I want to share some details on why I know this. First, last month I went to our fourth Thought Leadership workshop. It was in Washington, D.C., and we had a record turnout of more than 300 companies.
In a couple of weeks, I'll be attending our fifth Thought Leadership event, and already we have more than 300 registered there as well. The HR market is responding to us, and we are working closely with them to produce solutions that best address their day-to-day administrative and strategic needs. Demand for what we have to offer has very plainly not slowed down. In fact, the momentum has increased.
Second, the results of the Forrester Wave Human Resource Management Systems for 2008 were just published. Forrester Research is an independent technology and market research firm that provides the international business community with advice about technology, and they described Ultimate Software's product as the best of the HR Management Systems for the United States midmarket, and called Ultimate "the only leader in that space".
Ultimate Software received the highest overall score among all vendors evaluated, and specifically, the highest score in product strategy and vision, cost and value in overall current offering. Forrester also named Ultimate Software a leader and the top-score vendor for strategy in the multinational enterprise wave for HR systems.
Here's a quote from the Forrester analyst Paul Hammerman, the lead author of the report. "Ultimate Software leads the pack. Ultimate Software's well-rounded HRMS solution has strong core transactional capabilities, including payroll, as well as good flexibility and usability. The product is sold mostly via the SaaS model and good cost and time-to-value factors, making it appealing to midsize US companies as well as enterprises."
Last, I want to share some detail from our first annual user conference last week in Atlanta, where we hosted 700 of our client associates. It is so clear to me that the road to greatness is about having the best products and services.
The positive feedback and raves that we hear from our customers tell us that we are on the right path. Some of the quotes from people who were there may give you an idea of the value our customers are receiving from our products, and their level of satisfaction. From Excella Health, an organization with 4,900 employees, three hospitals and 10 component companies, "We can now unify our distributed workforce with self-service and our employees love it".
From Christiana Care Health Systems, "Ultimate is our people system and it is the center of all processes and systems that touch both employees and non-employees. At night, UltiPro feeds dozens of applications and departments in our 11,000 employee and 7,000 non-employee companies. We are so pleased that UltiPro has helped us move to a paperless HR environment so quickly."
From International Dairy Queen, "We love Ultimate. The culture radiates, and compared to the service bureau we used before, processing our payroll has been like day and night."
From Trader Joe's, the gourmet grocery store chain with more than 20,000 employees and 300 stores, "UltiPro's reports have been the number one lifesaver for us. We used to have to go to IT for every report, and wait. With UltiPro, we are managing compliance more effectively and staying on top of changing workforce trends. By empowering our managers with UltiPro's manager self-service, we have moved entry to the people closest to the transaction, reducing data entry for HR, and improving accuracy."
From Washington Trust Bank, "Your support is phenomenal." From Sony BMG Entertainment, "Now that we are live on UltiPro, I can easily net out the benefits compared to the highly-rated Enterprise system we used previously. UltiPro is better, cheaper, and faster." One person even told us that he went to work for a company just because they used UltiPro, and he loves working with UltiPro better than any other system he has ever used
In tough times like these, it is so refreshing to hear our customers tell us how much our solutions help them. Quality products matter to business, quality services matters, and strong relationships make an impact. Our customers told us in large numbers that they want to be references for us.
Ultimate Software is in a very good position to continue executing in the toughest of times, and we intend to continue our growth in the fourth quarter of this year and in 2009.
Let's go to the Q&A, Dustin.