The Ultimate Software Group Inc 10Q 2007 Q3 Quarterly report

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q


þ		QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2007


o		TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from to

Commission file number: 0-24347

THE ULTIMATE SOFTWARE GROUP, INC.

(Exact name of Registrant as specified in its charter)


Delaware		65-0694077

(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification No.)


2000 Ultimate Way, Weston, FL		33326

(Address of principal executive offices)		(Zip Code)

(954) 331-7000
(Registrant’s telephone number, including area code)

None
(Former name, former address and former fiscal year, if changed since last report)

Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yesþ Noo

Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):


Large accelerated filero		Accelerated filerþ		Non-accelerated filero

Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yeso Noþ

As of October 10, 2007, there were 24,705,238 shares of the Registrant’s Common Stock, par value $0.01, outstanding.

THE ULTIMATE SOFTWARE GROUP, INC. AND SUBSIDIARIES

TABLE OF CONTENTS


	Page(s)
Part I — Financial Information:

Item 1 — Financial Statements:
Unaudited Condensed Consolidated Balance Sheets as of September 30, 2007 and December 31, 2006		3
Unaudited Condensed Consolidated Statements of Operations for the Three Months and Nine Months Ended September 30, 2007 and 2006		4
Unaudited Condensed Consolidated Statements of Cash Flows for the Nine Months Ended September 30, 2007 and 2006		5
Unaudited Condensed Consolidated Statement of Stockholders’ Equity and Comprehensive Income for the Nine Months Ended September 30, 2007		6
Notes to Unaudited Condensed Consolidated Financial Statements		7-16

Item 2 — Management’s Discussion and Analysis of Financial Condition and Results of Operations		17-27

Item 3 — Quantitative and Qualitative Disclosures About Market Risk		27-28

Item 4 — Controls and Procedures		28

Part II — Other Information:

Item 2 — Unregistered Sales of Equity Securities and Use of Proceeds		29

Item 6 — Exhibits		30

Signatures		31
Certifications
EX-21.1 Subsidiaries of the Registrant
EX-31.1 Section 302 CEO Certification
EX-31.2 Section 302 CFO Certification
EX-32.1 Section 906 CEO Certification
EX-32.2 Section 906 CFO Certification

PART 1 — FINANCIAL INFORMATION

Item 1 — Financial Statements

THE ULTIMATE SOFTWARE GROUP, INC. AND SUBSIDIARIES
UNAUDITED CONDENSED CONSOLIDATED BALANCE SHEETS
(Dollars in thousands, except share and per share data)


	As of			As of
	September 30,			December 31,
	2007			2006
ASSETS

Current assets:
Cash and cash equivalents	$	15,934		$	16,734
Accounts receivable, net of allowance for doubtful accounts of $600 and $500 for 2007 and 2006, respectively		29,055			26,575
Short-term investments in marketable securities		15,658			14,247
Prepaid expenses and other current assets		9,899			8,279

Total current assets		70,546			65,835

Property and equipment, net		16,616			13,480
Capitalized software, net		3,465			2,055
Goodwill		2,758			2,734
Long-term investments in marketable securities		643			2,039
Other assets, net		8,705			7,387

Total assets	$	102,733		$	93,530


LIABILITIES AND STOCKHOLDERS’ EQUITY

Current liabilities:
Accounts payable	$	5,373		$	3,894
Accrued expenses		7,987			9,230
Current portion of deferred revenue		38,852			36,524
Current portion of capital lease obligations		1,894			1,512
Current portion of long-term debt		614			505

Total current liabilities		54,720			51,665

Deferred revenue, net of current portion		7,527			6,445
Deferred rent		2,708			2,788
Capital lease obligations, net of current portion		1,871			1,416
Long-term debt, net of current portion		362			194

Total liabilities		67,188			62,508


Stockholders’ equity:
Preferred Stock, $.01 par value, 2,000,000 shares authorized, no shares issued or outstanding		—			—
Series A Junior Participating Preferred Stock, $.01 par value, 500,000 shares authorized, no shares issued or outstanding		—			—
Common Stock, $.01 par value, 50,000,000 shares authorized, 26,043,094 and 25,102,824 shares issued in 2007 and 2006, respectively		260			251
Additional paid-in capital		138,568			125,121
Accumulated other comprehensive income		7			1
Accumulated deficit		(73,477	)		(83,500	)

		65,358			41,873
Treasury stock, 1,364,375 and 709,437 shares, at cost, for 2007 and 2006, respectively		(29,813	)		(10,851	)

Total stockholders’ equity		35,545			31,022

Total liabilities and stockholders’ equity	$	102,733		$	93,530

The accompanying Notes to Unaudited Condensed Consolidated Financial Statements are an integral part of these financial statements.

THE ULTIMATE SOFTWARE GROUP, INC. AND SUBSIDIARIES
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share amounts)


	For the Three Months						For the Nine Months
	Ended September 30,						Ended September 30,
	2007			2006			2007			2006
Revenues:
Recurring	$	22,174		$	16,487		$	62,720		$	46,456
Services		12,312			9,410			35,773			25,972
License		3,337			2,882			10,829			9,340

Total revenues		37,823			28,779			109,322			81,768


Cost of revenues:
Recurring		5,630			4,602			16,609			13,040
Services		10,066			7,287			29,439			20,655
License		352			319			1,026			966

Total cost of revenues		16,048			12,208			47,074			34,661

Gross profit		21,775			16,571			62,248			47,107


Operating expenses:
Sales and marketing		9,040			7,222			26,265			21,711
Research and development		7,107			5,887			20,941			16,533
General and administrative		3,645			2,526			10,345			7,524

Total operating expenses		19,792			15,635			57,551			45,768

Operating income		1,983			936			4,697			1,339

Other income (expense):
Interest expense		(61	)		(52	)		(161	)		(152	)
Other income, net		433			419			5,602			1,148

Total other income, net		372			367			5,441			996

Income before provision for income taxes		2,355			1,303			10,138			2,335
Provision for income taxes		—			—			(115	)		—

Net income	$	2,355		$	1,303		$	10,023		$	2,335


Net income per share:
Basic	$	0.10		$	0.05		$	0.41		$	0.10

Diluted	$	0.09		$	0.05		$	0.36		$	0.09


Weighted average shares outstanding:
Basic		24,764			24,130			24,688			23,713

Diluted		27,692			27,030			27,577			26,891

The accompanying Notes to Unaudited Condensed Consolidated Financial Statements are an integral part of these financial statements.

THE ULTIMATE SOFTWARE GROUP, INC. AND SUBSIDIARIES
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)


	For the Nine Months
	Ended September 30,
	2007			2006
Cash flows from operating activities:
Net income	$	10,023		$	2,335
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization		5,071			3,727
Provision for doubtful accounts		1,075			873
Non-cash stock-based compensation expense		7,294			4,264
Changes in operating assets and liabilities:
Accounts receivable		(3,555	)		(3,336	)
Prepaid expenses and other current assets		(1,620	)		(1,737	)
Other assets		(1,478	)		(2,244	)
Accounts payable		1,479			1,190
Accrued expenses and deferred rent		(1,323	)		1,068
Deferred revenue		3,410			4,141

Net cash provided by operating activities		20,376			10,281


Cash flows from investing activities:
Purchases of marketable securities		(13,629	)		(17,903	)
Maturities of marketable securities		13,614			15,383
Capitalized software		(1,391	)		(1,273	)
Acquisition-related expenses		(24	)		—
Purchases of property and equipment		(4,777	)		(4,725	)

Net cash used in investing activities		(6,207	)		(8,518	)


Cash flows from financing activities:
Repurchases of Common Stock		(18,962	)		(9,797	)
Principal payments on capital lease obligations		(1,452	)		(1,247	)
Repayments of borrowings of long-term debt		(684	)		(376	)
Net proceeds from issuances of Common Stock		6,123			6,236

Net cash used in financing activities		(14,975	)		(5,184	)


Effect of foreign currency exchange rate changes on cash		6			—
Net decrease in cash and cash equivalents		(800	)		(3,421	)
Cash and cash equivalents, beginning of period		16,734			17,731

Cash and cash equivalents, end of period	$	15,934		$	14,310


Supplemental disclosure of cash flow information:
Cash paid for interest	$	73		$	79

Supplemental disclosure of non-cash financing activities:
– The Company entered into capital lease obligations to acquire new equipment totaling $2,289 and $1,433 during the nine months ended September 30, 2007 and 2006, respectively.
– The Company entered into a long-term installment loan agreement with a vendor to acquire computer software totaling $961 during the nine months ended September 30, 2007.

The accompanying Notes to Unaudited Condensed Consolidated Financial Statements are an integral part of these financial statements.

THE ULTIMATE SOFTWARE GROUP, INC. AND SUBSIDIARIES
UNAUDITED CONDENSED CONSOLIDATED STATEMENT OF STOCKHOLDERS’ EQUITY AND
COMPREHENSIVE INCOME
(In thousands)


							Accumulated
					Additional		Other										Total
	Common Stock				Paid-in		Comprehensive		Accumulated			Treasury Stock					Stockholders’
	Shares		Amount		Capital		Income		Deficit			Shares		Amount			Equity
Balance, December 31, 2006		25,103	$	251	$	125,121	$	1	$	(83,500	)		709	$	(10,851	)	$	31,022
Net income		—		—		—		—		10,023			—		—			10,023
Unrealized gain on foreign currency translation		—		—		—		6		—			—		—			6

Comprehensive income		—		—		—		—		—			—		—			10,029

Repurchases of Common Stock		—		—		—		—		—			655		(18,962	)		(18,962	)
Issuances of Common Stock from exercises of stock options and warrants		940		9		6,114		—		—			—		—			6,123
Non-cash stock-based compensation		—		—		7,333		—		—			—		—			7,333

Balance, September 30, 2007		26,043	$	260	$	138,568	$	7	$	(73,477	)		1,364	$	(29,813	)	$	35,545

The accompanying Notes to Unaudited Condensed Consolidated Financial Statements are an integral part of these financial statements.

THE ULTIMATE SOFTWARE GROUP, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

1. Basis of Presentation

The accompanying unaudited condensed consolidated financial statements of The Ultimate Software Group, Inc. and subsidiaries (the “Company”) have been prepared, without audit, pursuant to the rules and regulations of the Securities and Exchange Commission (the “SEC”). Certain information and footnote disclosures normally included in financial statements in accordance with U.S. generally accepted accounting principles (“GAAP”) have been condensed or omitted pursuant to such rules and regulations. The information in this report should be read in conjunction with the Company’s audited consolidated financial statements and notes thereto included in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2006 filed with the SEC on March 16, 2007 (the “Form 10-K”).

The unaudited condensed consolidated financial statements included herein reflect all adjustments (consisting only of normal, recurring adjustments), which are, in the opinion of the Company’s management, necessary for a fair presentation of the information for the periods presented. The preparation of financial statements in conformity with GAAP 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. Interim results of operations for the three and nine months ended September 30, 2007 and 2006 are not necessarily indicative of operating results for the full fiscal years or for any future periods.

The unaudited condensed consolidated financial statements reflect the financial position and operating results of the Company and include its wholly-owned subsidiaries. Intercompany accounts and transactions have been eliminated in consolidation.

2. Summary of Significant Accounting Policies and Recent Accounting Pronouncements

Summary of Significant Accounting Policies

The Company’s significant accounting policies are discussed in Note 2 to its audited consolidated financial statements for the fiscal year ended December 31, 2006, included in the Form 10-K. These accounting policies have not significantly changed.

Recently Adopted Accounting Pronouncements

Effective January 1, 2007, the Company adopted FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes” (“FIN No. 48”). The interpretation clarifies the accounting for uncertainty in income taxes recognized in a company’s financial statements in accordance with Statement of Financial Accounting Standards No. 109, “Accounting for Income Taxes.” Specifically, the interpretation prescribes a recognition threshold and a measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. The interpretation also provides guidance on the related derecognition, classification, interest and penalties, accounting for interim periods, disclosure and transition of uncertain tax positions. As of January 1, 2007 and September 30, 2007, the Company believes that no reserves for uncertain income tax positions need to be recorded pursuant to FIN No. 48. The Company has net operating loss carryforwards expiring at various times through the year 2026 of $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 Company’s equity instruments. Tax years 1996 to 2006 remain subject to future examination by the major tax jurisdictions in which the Company is subject to tax. The adoption of FIN No. 48 did not have an impact on the Company’s unaudited condensed consolidated financial statements.

In May 2007, the FASB published FASB Staff Position FIN 48-1, “Definition of Settlement in FASB Interpretation No. 48” (“FSP FIN 48-1”), which is an amendment to FIN No. 48. It clarifies how an enterprise should determine whether a tax position is effectively settled for the purpose of recognizing previously unrecognized tax benefits. The Company’s accounting is consistent with the guidance in FSP FIN 48-1.

Effective January 1, 2007, the Company adopted the Emerging Issues Task Force Issue No. 06-3, “How Taxes Collected from Customers and Remitted to Governmental Authorities Should Be Presented in the Income Statement (That is, Gross versus Net Presentation)” (“EITF No. 06-3”). EITF No. 06-3 allows entities to adopt a policy of presenting taxes in the income statement either on a gross or net basis. Gross or net presentation may be elected for each different type of tax, but similar taxes should be presented consistently. Taxes within the scope of EITF No. 06-3 would include taxes that are imposed on a revenue transaction between the seller and a customer (e.g., sales taxes, use taxes, value-added taxes, and some types of excise taxes). The adoption of EITF No. 06-3 did not have an impact on the Company’s unaudited condensed consolidated financial statements.

Recently Issued Accounting Pronouncements

In February 2007, the FASB issued Statement of Financial Accounting Standards No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities; including an amendment of FASB Statement No. 115” (“SFAS No. 159”). SFAS No. 159 permits entities to choose to measure many financial instruments and certain other items at fair value. Most of the provisions of SFAS No. 159 apply only to entities that elect the fair value option. However, the amendment to FASB Statement No. 115, “Accounting for Certain Investments in Debt and Equity Securities” (“SFAS No. 115”), applies to all entities with available-for-sale and trading securities. SFAS No. 159 is effective for the Company’s consolidated financial statements for the annual reporting period beginning after November 15, 2007. The Company is currently evaluating the impact of this new pronouncement on its consolidated financial statements.

In September 2006, the FASB issued Statement of Financial Accounting Standards No. 157, “Fair Value Measurements” (“SFAS No. 157”). SFAS No. 157 defines fair value as used in numerous accounting pronouncements, establishes a framework for measuring fair value in GAAP and expands disclosures related to the use of fair value measures in financial statements. SFAS No. 157 does not expand the use of fair value measures in financial statements, but standardizes its definition and guidance in GAAP and emphasizes that fair value is a market-based measurement and not an entity-specific measurement based on an exchange transaction in which the entity sells an asset or transfers a liability (exit price). SFAS No. 157 establishes a fair value hierarchy from observable market data as the highest level to fair value based on an entity’s own fair value assumptions as the lowest level. SFAS No. 157 is effective for the Company’s consolidated financial statements for interim and annual reporting periods beginning after November 15, 2007. The Company is currently evaluating the impact of this new pronouncement on its consolidated financial statements.

3. Investments in Marketable Securities

The Company classifies its investments in marketable securities with readily determinable fair values as securities available-for-sale in accordance with Statement of Financial Accounting Standards No. 115, “Accounting for Certain Investments in Debt and Equity Securities” and FASB Staff Position Financial Accounting Standards No. 115-1, “The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments”. The Company has classified all investments as available-for-sale. Available-for-sale securities consist of debt and equity securities not classified as trading securities or as securities to be held to maturity. Unrealized holding gains and losses on securities available-for-sale are reported as a net amount in accumulated other comprehensive income in stockholders’ equity until realized. Gains and losses on the sale of securities available-for-sale are determined using the specific identification method. Included in accumulated other comprehensive income is $2 thousand of unrealized gains on available-for-sale securities at September 30, 2007 and $2 thousand of unrealized gains on available-for-sale securities held at December 31, 2006.

The amortized cost and market value of the Company’s investments in marketable securities available-for-sale at September 30, 2007 are shown in the table below (in thousands):


			Gross		Gross
	Amortized		Unrealized		Unrealized		Market
	Cost		Gain		Loss		Value
Investments in marketable securities:
Corporate debentures — bonds	$	11,471	$	4	$	7	$	11,468
Commercial paper		647		—		—		647
Certificates of deposit		1,200		—		—		1,200
Asset-backed — fixed		2,983		3		—		2,986

Total investments, available-for-sale	$	16,301	$	7	$	7	$	16,301

The amortized cost and market value of the available-for-sale securities by contractual maturity at September 30, 2007 are shown below (in thousands):


	Amortized		Market
	Cost		Value
Due in one year or less	$	15,660	$	15,658
Due after one year		641		643

	$	16,301	$	16,301

4. Property and Equipment

Property and equipment is stated at cost, net of accumulated depreciation and amortization. Property and equipment is depreciated using the straight-line method over the estimated useful lives of the assets, which range from two to twenty years. Leasehold improvements and assets under capital leases are amortized over the shorter of the life of the asset or the term of the lease over periods ranging from two to fifteen years. Maintenance and repairs are charged to expense when incurred; betterments are capitalized. Upon the sale or retirement of assets, the cost, accumulated depreciation and amortization are removed from the accounts and any gain or loss is recognized.

Property and equipment consisted of the following (in thousands):


	As of		As of
	September 30, 2007		December 31, 2006
Property and equipment	$	49,008	$	41,173
Less: accumulated depreciation and amortization		32,392		27,693

	$	16,616	$	13,480

5. Goodwill and Other Intangible Assets

Goodwill and other intangible assets with indefinite lives are not subject to amortization, but are subject to an impairment test at least annually or more frequently if events or circumstances indicate that impairment might exist. SFAS No. 142, “Goodwill and Other Intangible Assets”, also requires that intangible assets with definite lives be amortized over their estimated useful lives and reviewed for impairment in accordance with SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets”. The $0.8 million balance of the acquired intangibles, net of amortization, is included in other assets on the Company’s unaudited condensed consolidated balance sheets. The Company is currently amortizing its acquired intangible assets with finite lives over periods ranging from five to six years.

6. Other Income, net

Other income, net, consisted of the following (in thousands):


	For the three months				For the nine months
	ended September 30,				ended September 30,
	2007		2006		2007		2006
Interest income	$	375	$	356	$	1,087	$	970
Other income		58		63		140		178
Non-recurring settlement fee, net		–		–		4,375		–

Total other income, net	$	433	$	419	$	5,602	$	1,148

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.

7. Earnings Per Share

SFAS No. 128, “Earnings Per Share,” requires dual presentation of earnings per share — “basic” and “diluted.” Basic earnings per share is computed by dividing income available to common stockholders (the numerator) by the weighted average number of common shares outstanding (the denominator) for the period. The computation of diluted earnings per share is similar to basic earnings per share, except that the denominator is increased to include the number of additional common shares that would have been outstanding if the potentially dilutive common shares had been issued.

The following is a reconciliation of the shares used in the computation of basic and diluted net income per share (in thousands):


	For the three months				For the nine months
	ended September 30,				ended September 30,
	2007		2006		2007		2006
Basic weighted average shares outstanding		24,764		24,130		24,688		23,713
Effect of dilutive equity instruments		2,928		2,900		2,889		3,178

Dilutive weighted average shares outstanding		27,692		27,030		27,577		26,891


Other common stock equivalents (i.e., stock options, restricted stock awards, stock units and warrants) outstanding which are not included in the calculation of diluted income per share because their impact is anti-dilutive		179		523		634		383

8. Comprehensive Income

SFAS No. 130, “Reporting Comprehensive Income” (“SFAS No. 130”), establishes standards for the reporting and display of comprehensive income and its components in the Company’s unaudited condensed consolidated financial statements. The objective of SFAS No. 130 is to report a measure (comprehensive income) of all changes in equity of an enterprise that result from transactions and other economic events in a period other than transactions with owners. Accumulated other comprehensive income, as presented on the accompanying unaudited condensed consolidated balance sheets, consists of unrealized gains and losses on available-for-sale securities and foreign currency translation adjustments, recorded net of any related tax.

Comprehensive income for the three and nine months ended September 30, 2007 and 2006 was as follows (in thousands):


	For the three months				For the nine months
	ended September 30,				ended September 30,
	2007		2006		2007		2006
Net income	$	2,355	$	1,303	$	10,023	$	2,335
Other comprehensive income
Unrealized gain on investments in marketable securities available-for-sale		14		42		—		33
Unrealized gain on foreign currency translation adjustments		1		—		6		—

Comprehensive income	$	2,370	$	1,345	$	10,029	$	2,368

9. Foreign Currency

The financial statements of the Company’s foreign subsidiaries have been translated into U.S. dollars. The functional currency of The Ultimate Software Group of Canada, Inc. is the Canadian dollar and the functional currency of The Ultimate Software Group UK Limited is the British pound. Assets and liabilities are translated into U.S. dollars at period-end exchange rates, while fixed assets and equity accounts are translated at historical rates. Income and expenses are translated at the average exchange rate for the reporting period. The resulting translation adjustments, representing unrealized gains or losses, are included in stockholders’ equity as a component of accumulated other comprehensive income. Realized gains and losses resulting from foreign exchange transactions are included in total operating

costs in the unaudited condensed consolidated statements of operations. The Company had unrealized translation gains of $1 thousand and $6 thousand for the three months and nine months ended September 30, 2007, respectively.

10. Guarantees

The Company applies the provisions of FASB Interpretation No. 45, “Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others” (“FIN No. 45”). The provision for initial recognition and measurement of a liability is applied on a prospective basis to guarantees issued or modified after December 31, 2002. FIN No. 45 expands previously issued accounting guidance and disclosure requirements for certain guarantees and requires recognition of an initial liability for the fair value of an obligation assumed by issuing a guarantee. As an element of standard commercial terms in its standard sales contracts for UltiPro, the Company includes an indemnification clause that indemnifies the customer against certain liabilities and damages arising from any claims of patent, copyright, or other proprietary rights of any third party. Due to the nature of the intellectual property indemnification provided to its customers, the Company cannot estimate the fair value, or determine the total nominal amount, of the indemnification until such time as a claim for such indemnification is made. In the event of a claim made against the Company under such provision, the Company evaluates estimated losses for such indemnification under SFAS No. 5, “Accounting for Contingencies,” as interpreted by FIN No. 45, considering such factors as the degree of probability of an unfavorable outcome and the ability to make a reasonable estimate of the amount of loss. To date, the Company has not had any claims made against it under such provision and, accordingly, has not accrued any liabilities related to such indemnifications in its unaudited condensed consolidated financial statements.

11. Stock-Based Compensation

Summary of Plans

The Company’s Amended and Restated 2005 Equity and Incentive Plan (the “Plan”) authorizes the grant of options to directors, officers and employees of the Company to purchase shares of the Company’s Common Stock. The Plan also authorizes the grant to such persons of restricted and non-restricted shares of Common Stock, stock appreciation rights, stock units and cash performance awards (collectively, and together with stock options, the “Awards”). Prior to the adoption of the Plan, options to purchase shares of Common Stock were issued under the Company’s Nonqualified Stock Option Plan (the “Prior Plan”).

On January 1, 2006, the Company adopted the provisions of SFAS No. 123 (revised 2004), “Share-Based Payment” (“SFAS No. 123R”), which requires the Company to recognize expense related to the fair value of stock-based compensation awards. The Company elected the modified prospective transition method as permitted by SFAS No. 123R. Under the modified prospective transition method, stock based compensation expense for the three and nine months ended September 30, 2007 and 2006 includes compensation expense for all stock-based compensation awards granted prior to, but not yet vested as of, January 1, 2006, based on the grant date fair value estimated in accordance with the provisions of SFAS No. 123 and compensation expense for all stock-based compensation awards granted subsequent to January 1, 2006, based on the grant date fair value estimated in accordance with the provisions of SFAS No. 123R.

As of September 30, 2007, the aggregate number of shares of Common Stock authorized under the Plan and the Prior Plan was 12,000,000 and the aggregate number of shares of Common Stock that were available to be issued under all Awards granted under the Plan was 2,785,912 shares. Options

granted to officers and employees under the Plan and the Prior Plan generally have a 10-year term, vesting 25% immediately and 25% on each of the first three anniversaries of the grant date . Options granted to non-employee directors under the Plan and the Prior Plan generally have a 10-year term and vest and become exercisable immediately on the grant date. However, certain options granted to non-employee directors for board services during the period January 3, 2005 through July 2, 2007 first become exercisable on the earliest of (i) the fifth anniversary of the date of grant, (ii) the date on which the director ceases to be a member of the Board of Directors of the Company (the “Board”) or (iii) the effective date of a change in control of the Company.

Prior to July 24, 2007, non-employee directors received discounted options under the Plan and the Prior Plan as compensation for their services. On that date, the Compensation Committee of the Board rescinded the previously approved fee schedule for service on the Board and Board Committees and replaced it with a program involving market price options and restricted stock awards under the Plan. Under resolutions adopted by the Compensation Committee, commencing with the third calendar quarter of 2007, (i) each non-employee director shall be granted an option to purchase 3,750 shares of the Company’s Common Stock for each regular quarterly meeting of the Board attended in 2007, dated as of the date of such meeting, at an exercise price equal to the closing price of the Company’s Common Stock on NASDAQ on the date of such meeting, and (ii) each of the Chairman of the Audit Committee of the Board and the Chairman of the Compensation Committee of the Board shall be granted an option to purchase 2,500 shares of the Company’s Common Stock for each calendar quarter in 2007, dated as of the date of the regularly scheduled meeting of such Committee during such quarter, at an exercise price equal to the closing price of the Company’s Common Stock on NASDAQ on the date of such meeting. These option grants shall vest immediately upon grant.

In addition to the option grants discussed above, commencing with the third calendar quarter of 2007, each non-employee director shall be granted a restricted stock award under the Plan for each calendar quarter in 2007, dated as of the date of the regularly scheduled meeting of the Compensation Committee during such quarter, of that number of shares of the Company’s Common Stock equal to the quotient of $12,500 divided by the closing price of the Company’s Common Stock on NASDAQ on the date of such meeting, rounded down to the nearest full number of shares. The restricted stock awards shall vest on the fourth anniversary of the date of grant, subject to accelerated vesting in the event of a director’s death, disability, cessation of service at the end of his term or the occurrence of a change in control of the Company.

Stock-Based Compensation

The following table sets forth the stock-based compensation resulting from stock-based arrangements that was recorded in the Company’s unaudited condensed consolidated statements of operations for the periods indicated (in thousands):


	For the three months				For the nine months
	ended September 30,				ended September 30,
	2007		2006		2007		2006
Non-cash stock-based compensation:
Cost of recurring revenues	$	161	$	89	$	489	$	289
Cost of service revenues		330		157		1,242		605
Cost of license revenues		1		1		4		5
Sales and marketing		1,151		797		3,274		2,134
Research and development		213		117		753		413
General and administrative		701		266		1,532		818

Total non-cash stock-based compensation expense	$	2,557	$	1,427	$	7,294	$	4,264

Included in capitalized software in the Company’s unaudited condensed consolidated balance sheets at September 30, 2007 and December 31, 2006 was $39 thousand and $41 thousand, respectively, in stock-based compensation incurred in the development of UltiPro Canadian HR/Payroll (“UltiPro Canada”) during the nine months ended September 30, 2007 and the year ended December 31, 2006. These amounts would have otherwise been charged to research and development expense in the unaudited condensed consolidated statements of operations for the nine months ended September 30, 2007 and the year ended December 31, 2006.

Net cash proceeds from the exercise of stock options and warrants were $2.1 million and $6.1 million for the three and nine months ended September 30, 2007, respectively, and $0.9 million and $6.2 million for the three and nine months ended September 30, 2006, respectively. No income tax benefit was realized from stock option exercises during the three and nine months ended September 30, 2007 and 2006.

The fair value of stock-based awards was estimated using the Black-Scholes model with the following weighted-average assumptions for the three and nine months ended September 30, 2007 and 2006 (dollars in thousands):


	For the three months						For the nine months
	ended September 30,						ended September 30,
	2007			2006			2007			2006
Expected term (in years)		5.0			4.7			5.0			4.6
Volatility		39	%		41	%		39	%		40	%
Interest rate		4.63	%		4.88	%		4.64	%		4.79	%
Dividend yield		—			—			—			—
Weighted average fair value at grant date	$	12.67		$	7.85		$	10.80		$	8.61

Restricted Stock Awards

Under the provisions of the Plan, the Company may, at its discretion, grant restricted stock awards (“Restricted Stock Awards”) to officers, employees and non-employee directors. The shares of Common Stock issued under Restricted Stock Awards are subject to certain vesting requirements and restrictions on transfer. During the three months ended September 30, 2007 and September 30, 2006, there were no grants of Restricted Stock Awards for shares of Common Stock to certain officers or employees. During the nine months ended September 30, 2007 and September 30, 2006, the Company granted Restricted Stock Awards for an aggregate of 105,000 shares and 105,000 shares, respectively, of Common Stock to certain officers and employees. During the three months and nine months ended September 30, 2007, the Company granted Restricted Stock Awards for an aggregate of 2,055 shares of Common Stock to non-employee directors. There were no grants of Restricted Stock Awards for the three and nine months ended September 30, 2006 to non-employee directors. Included in the Company’s unaudited condensed consolidated statements of operations for the three and nine months ended September 30, 2007 was $0.7 million and $2.1 million, respectively, of stock-based compensation expense for Restricted Stock Awards. There was $0.3 million and $0.9 million of stock-based compensation expense for Restricted Stock Awards included in the Company’s unaudited condensed consolidated statements of operations for the three and nine months ended September 30, 2006, respectively.

Stock Unit Awards

The Company may, at its discretion, make awards of stock units under the Plan (“Stock Unit Awards”) to certain officers and employees. A Stock Unit Award is a grant of a number of hypothetical share units with respect to shares of Common Stock that are subject to vesting and transfer restrictions and conditions under a stock unit award agreement. The value of each unit is equal to the fair market value of one share of Common Stock on any applicable date of determination. The payment with respect to each unit under a Stock Unit Award may be made, at the discretion of the Compensation Committee, in cash or shares of Common Stock or in a combination of both. The grantee of a Stock Unit Award does not have any rights as a stockholder with respect to the shares subject to a Stock Unit Award until such time as shares of Common Stock are delivered to the grantee pursuant to the terms of the related stock unit award agreement.

There were no grants of Stock Unit Awards during the three months ended September 30, 2007 or 2006. During the nine months ended September 30, 2007 and 2006, the Company granted an aggregate of 16,603 stock units and 28,518 stock units, respectively, to certain officers, of which none have been forfeited as of September 30, 2007. Included in the Company’s unaudited condensed consolidated statements of operations for the three and nine months ended September 30, 2007 was $19 thousand and $57 thousand, respectively, of stock-based compensation expense for Stock Unit Awards. During the three and nine months ended September 30, 2006, $18 thousand and $41 thousand, respectively, of stock-based compensation expense for Stock Unit Awards was included in the Company’s unaudited condensed consolidated statements of operations.

Stock Option and Restricted Stock Activity

The following table summarizes stock option activity for the nine months ended September 30, 2007, (in thousands, except per share amounts):


						Weighted
						Average
				Weighted		Remaining		Aggregate
				Average		Contractual		Intrinsic
Stock Options	Shares			Exercise Price		Term (in Years)		Value
Outstanding at December 31, 2006		4,893		$	10.07		—		—
Granted		696			25.72		—		—
Exercised		(870	)		6.90		—		—
Forfeited or expired		(30	)		22.11		—		—

Outstanding at September 30, 2007		4,689		$	12.90		6.02	$	103,151


Exercisable at September 30, 2007		3,587		$	10.14		5.21	$	88,839

The aggregate intrinsic value of stock options in the table above represents total pretax intrinsic value (i.e., the difference between the closing price of the Company’s Common Stock on the last trading day of the reporting period and the exercise price, times the number of shares) that would have been received by the option holders had all option holders exercised their options on September 30, 2007. The amount of the aggregate intrinsic value changes, based on the fair value of the Company’s Common Stock. Total intrinsic value of options exercised was $5.9 million and $18.5 million for the three and nine months ended September 30, 2007, respectively, and $2.3 million and $16.4 million for the three and nine months ended September 30, 2006, respectively. Total fair value of options vested during the three and nine months ended September 30, 2007 was $1.0 million and $4.1 million, respectively, and $1.5 million and $3.4 million during the three and nine months ended September 30, 2006, respectively.

As of September 30, 2007, $6.6 million of total unrecognized compensation costs related to non-vested stock options is expected to be recognized over a weighted average period of 1.7 years.

The following table summarizes restricted stock activity for the nine months ended September 30, 2007, (in thousands, except per share amounts):


			Weighted
			Average
			Grant Date
Restricted Stock	Shares		Fair Value
Outstanding at December 31, 2006		432	$	20.70
Granted		107		25.94
Vested		—		—
Forfeited or expired		—		—

Outstanding at September 30, 2007		539	$	21.74

As of September 30, 2007, $8.0 million of total unrecognized compensation costs related to non-vested Restricted Stock Awards is expected to be recognized over a weighted average period of 2.7 years. As of September 30, 2007, $0.2 million of total unrecognized compensation costs related to non-vested Stock Unit Awards is expected to be recognized over a weighted average period of 2.7 years.


ITEM 2.		Management’s Discussion and Analysis of Financial Condition and Results of Operations

The following discussion of the financial condition and results of operations of The Ultimate Software Group, Inc. (“Ultimate Software” or the “Company”) should be read in conjunction with the unaudited Condensed Consolidated Financial Statements and Notes thereto included elsewhere in this Quarterly Report on Form 10-Q.

Executive Summary

Ultimate Software designs, markets, implements and supports human resources, payroll and talent management solutions.

Ultimate Software’s UltiPro software (“UltiPro”) is an end-to-end, single source 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 customer’s processes are centralized at headquarters or distributed across multiple divisions or branch offices. UltiPro’s end-to-end functionality includes comprehensive online recruitment tools, human resources (“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 Company’s main sources of revenues include sales from the Intersourcing Offering (defined below), 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 Company’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 Company’s business strategy was centered on sales of perpetual software licenses of UltiPro.

The primary sources of the Company’s recurring revenue stream are hosting services, branded “Intersourcing” and product maintenance (i.e., software updates and telephone customer support). Other recurring revenue sources include subscription revenues from third-party business service providers (“BSPs”) and recurring revenues from the Original Ceridian Agreement. See also “Original Ceridian Agreement” below.

Ultimate Software offers hosting services at two separate data center locations—the original location in Miami, Florida, which was opened in 2002, and the location opened in August 2005 in Atlanta, Georgia. With Intersourcing, Ultimate Software provides the hardware, infrastructure, ongoing maintenance and back-up services for its customers at its data centers. Operations of the facilities at both data centers are managed by International Business Machines (“IBM”). Intersourcing is designed to appeal to those customers that want to minimize their internal technology support requirements for the application and hardware.

For the past several years (following the introduction of its Intersourcing Offering in 2002), the revenue mix in the Company’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 (“PEPM”) 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 “Live”). Ongoing monthly PEPM fees are recognized as recurring subscription revenues each month commencing when the related customer goes Live.

In connection with the Company’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 (“ARR”) represent the expected one-year value from (i) new Intersourcing sales from the Company’s hosted model (including prorated one-time fees); (ii) maintenance revenues related to new license sales; (iii) recurring revenues from new BSPs, as well as recurring revenues from new sales by existing BSPs; and (iv) recurring revenues from additional sales to Ultimate Software’s existing client base. New annual recurring revenues attributable to sales during the third fiscal quarter of 2007 were $7.1 million as compared to $5.1 million for the same period in 2006. New annual recurring revenues attributable to sales during the nine months ended September 30, 2007 were $20.1 million as compared to $16.5 million for the nine months ended September 30, 2006.

Intersourcing Offering

In 2002, the Company began offering a hosting service, branded Intersourcing, whereby the Company provides the hardware, infrastructure, ongoing maintenance and back-up services for its customers at a data center located in Miami, Florida, which is managed by IBM (“Hosting Services”). In August 2005, the Company opened a second data center, which is located in Atlanta, Georgia and is also managed by IBM. Different types of hosting arrangements include the sale of Hosting Services as a part of the Intersourcing Offering, discussed below, and, to a lesser extent, the sale of Hosting Services to customers that license UltiPro on a perpetual basis (“Base Hosting”). Hosting Services, typically available in a shared environment, provide Web access to UltiPro, including comprehensive learning management functionality for organizations that need to simplify the IT support requirements of their business applications and are priced on a PEPM basis. In the shared environment, Ultimate Software provides an infrastructure with applicable servers shared among many customers who use a Web browser to access the application software through the data centers.

The Intersourcing Offering is designed to provide an appealing pricing structure to customers who prefer to minimize the initial cash outlay associated with typical capital expenditures. Intersourcing customers purchase the right to use UltiPro on an ongoing basis for a specific term, typically in a shared environment. The pricing for Intersourcing, including both the hosting element as well as the right to use UltiPro, is on a PEPM basis.

Original Ceridian Agreement

During 2001, Ultimate Software and Ceridian Corporation (“Ceridian”) reached an agreement, as amended in 2002, which granted Ceridian a non-exclusive license to use UltiPro software as part of an

on-line offering that Ceridian can market primarily to businesses with under 500 employees (the “Original Ceridian Agreement”). Ceridian marketed that solution under the name SourceWeb.

Under the agreement, Ceridian is required to pay the Company a monthly license fee based on the number of employees paid using the licensed software. In 2007, Ceridian is required to make monthly payments of $551,250. The aggregate minimum payments that Ceridian is 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 $39.8 million under the Original Ceridian Agreement.

Effective March 9, 2006, Ceridian provided Ultimate Software with a two years’ 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 will terminate on March 9, 2008 (unless terminated earlier for an uncured material breach). Ceridian continues to be financially obligated to pay Ultimate Software a minimum monthly fee through the termination of the Original Ceridian Agreement. The minimum monthly fee payable to Ultimate Software by Ceridian in 2007 is $551,250 and was $525,000 in 2006.

Ultimate Software expects to continue to recognize a minimum of $642,000 per month in recurring subscription revenues from the Original Ceridian Agreement until its termination in March 2008.

Significant Accounting Policies and Estimates

The preparation of financial statements in conformity with U.S. GAAP 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.

The Company’s significant accounting policies are discussed in Management’s Discussion and Analysis of Financial Condition and Results of Operations included in the Form 10-K. These accounting policies have not significantly changed.

Results of Operations

The following table sets forth the unaudited condensed consolidated statements of operations data of the Company, as a percentage of total revenues, for the periods indicated.


	For the Three Months						For the Nine Months
	Ended September 30,						Ended September 30,
	2007			2006			2007			2006
Revenues:
Recurring		58.6	%		57.3	%		57.4	%		56.8	%
Services		32.6			32.7			32.7			31.8
License		8.8			10.0			9.9			11.4

Total revenues		100.0			100.0			100.0			100.0

Cost of revenues:
Recurring		14.9			16.0			15.2			15.9
Services		26.6			25.3			26.9			25.2
License		0.9			1.1			0.9			1.2

Total cost of revenues		42.4			42.4			43.0			42.3

Operating expenses:
Sales and marketing		23.9			25.1			24.0			26.6
Research and development		18.8			20.4			19.2			20.2
General and administrative		9.6			8.8			9.5			9.2

Total operating expenses		52.3			54.3			52.7			56.0

Operating income		5.3			3.3			4.3			1.7
Other income (expense):
Interest expense		(0.2	)		(0.2	)		(0.1	)		(0.2	)
Other income, net		1.1			1.4			5.1			1.4

Total other income, net		0.9			1.2			5.0			1.2

Income before income taxes		6.2			4.5			9.3			2.9

Provision for income taxes		—			—			(0.1	)		—

Net income		6.2	%		4.5	%		9.2	%		2.9	%

Revenues

The Company’s revenues are derived from three principal sources: recurring revenues, services revenues and software licenses (“license revenues”).

Recurring revenues consist of maintenance revenues, Intersourcing revenues from the Company’s hosted offering of UltiPro and subscription revenues from per-employee-per-month (“PEPM”) fees generated by BSP’s, principally Ceridian. Maintenance revenues are derived from maintaining, supporting and providing periodic updates for the Company’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 Company’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-2’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 Company’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 “live” (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 “live” 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 Company’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 Company’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 Company’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 (“UTA”), 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 Company’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.

Sales 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 “live” 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, “Accounting for the Costs of Computer Software to be Sold, Leased or Otherwise Marketed” (“SFAS No. 86”), 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 UltiPro’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 Company’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

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 “Non-Recurring Settlement”).

Income Taxes

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 Company’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 Company’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 Company’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 Company’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 Company’s stock repurchase plan.

Days sales outstanding, calculated on a trailing three-month basis (“DSO”), as of September 30, 2007 and 2006, were 71 days and 66 days, respectively. The increase in DSO’s as of September 30, 2007 was related to the increase in accounts receivable principally from incremental revenues generated.

Deferred revenues were $46.4 million at September 30, 2007 as compared to $43.0 million at December 31, 2006. The increase of $3.4 million in deferred revenues in 2007 was primarily due to increased sales from Intersourcing operations (which originate upon contract execution for the one-time fees and PEPM fees, payment for which are included in the contract payment terms), partially offset by a decrease in deferred maintenance and, to a lesser extent, the reduction in deferred revenues from Ceridian (from quarterly amortization of Ceridian recurring revenue attributable to the Original Ceridian Agreement) and a decrease in deferred services (as the prepayment of certain services were recognized as those services were performed). Substantially all of the total balance in deferred revenues is related to future recurring revenues, including deferred revenues related to Intersourcing.

The Company had a credit facility (the “Credit Facility”) with Silicon Valley Bank, which was secured by the Company’s eligible accounts receivable. The Credit Facility was comprised of a revolving line of credit (the “Revolver”) and an equipment term loan (the “Equipment Loan”). The Credit Facility’s Revolver expired on May 27, 2006. Based upon the strength and consistency of the cash flow position as well as management’s expectations for the next twelve months, the Company chose not to renew the Credit Facility upon its expiration. The Credit Facility’s Equipment Loan, while still effective, did not have any future borrowing capacity after May 27, 2006. The outstanding balance of $0.3 million under the Equipment Loan as of September 30, 2007 is payable on or before December 31, 2008. As of September 30, 2007, the Company was in compliance with all covenants included in the terms of the Credit Facility.

The Company believes that cash and cash equivalents, investments in marketable securities and cash generated from operations will be sufficient to fund its operations for at least the next 12 months. This belief is based upon, among other factors, management’s expectations for future revenue growth, controlled expenses and collections of accounts receivable.

Off-Balance Sheet Arrangements

The Company does not have any off-balance sheet arrangements (as that term is defined in applicable SEC rules) that are reasonably likely to have a current or future material effect on the Company’s financial condition, results of operations, liquidity, capital expenditures or capital resources.

Quarterly Fluctuations

The Company’s quarterly revenues and operating results have varied significantly in the past and are likely to vary substantially from quarter to quarter in the future. The Company’s operating results may fluctuate as a result of a number of factors, including, but not limited to, increased expenses (especially as they relate to product development and sales and marketing), timing of product releases, increased competition, variations in the mix of revenues, announcements of new products by the Company or its competitors and capital spending patterns of the Company’s customers. The Company establishes its expenditure levels based upon its expectations as to future revenues, and, if revenue levels are below expectations, expenses can be disproportionately high. A significant change in the revenue mix (between Intersourcing and perpetual license unit sales) could cause the quarterly results to differ considerably. A drop in near term demand for the Company’s products could significantly affect both revenues and profits in any quarter. Operating results achieved in previous fiscal quarters are not necessarily indicative of operating results for the full fiscal years or for any future periods. As a result of these factors, there can be no assurance that the Company will be able to maintain profitability on a quarterly basis. The Company believes that, due to the underlying factors for quarterly fluctuations, period-to-period comparisons of its operations are not necessarily meaningful and that such comparisons should not be relied upon as indications of future performance.

Forward-Looking Statements

The foregoing Management’s Discussion and Analysis of Financial Condition and Results of Operations and the following Quantitative and Qualitative Disclosures about Market Risk contain certain forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended (the “Securities Act”), and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). These forward-looking statements represent the Company’s expectations or beliefs, including, but not limited to, statements concerning the Company’s operations and financial performance and condition. Words such as “anticipates,” “expects,” “intends,” “plans,” “believes,” “seeks,” “estimates,” and similar expressions are intended to identify such forward-looking statements. These forward-looking statements are not guarantees of future performance and are subject to certain risks and uncertainties that are difficult to predict. The Company’s actual results could differ materially from those contained in the forward-looking statements due to risks and uncertainties associated with fluctuations in the Company’s quarterly operating results, concentration of the Company’s product offerings, development risks involved with new products and technologies, competition, the Company’s relationships with third parties, contract renewals with business partners, compliance by our customers with the terms of their contracts with us, and other factors disclosed in this Quarterly Report on Form 10-Q and the Annual Report on Form 10-K for the year ended December 31, 2006, including Exhibit 99.1 thereto, filed with the SEC on March 16, 2007. The Company undertakes no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise.

ITEM 3. Quantitative and Qualitative Disclosures About Market Risk

In the ordinary course of its operations, the Company is exposed to certain market risks, primarily interest rates. Uncertainties that are either non-financial or non-quantifiable, such as political, economic, tax, other regulatory or credit risks are not included in the following assessment of the Company’s market risks.

Market risks.The Company manages market risk in accordance with its investment guideline objectives, including:

	•		Maximum safety of principal;

	•		Maintenance of appropriate liquidity for regular cash needs;

	•		Maximum yields in relationship to guidelines and market conditions;

	•		Diversification of risks; and

	•		Fiduciary control of all investments.

The Company targets its fixed income investment portfolio to have maturities of 24 months or less. Investments are held to enhance the preservation of capital and not for trading purposes.

Interest rates. Cash equivalents consist of money market accounts with original maturities of less than three months. Short-term investments include obligations of U.S. government agencies and corporate debt securities. Corporate debt securities include commercial paper which must carry minimum short-term ratings of P-1 by Moody’s Investor Service, Inc. (“Moody’s”) and A-1 by Standard & Poor’s Ratings Service, a Division of The McGraw-Hill Companies, Inc. (“S&P”). Other corporate debt obligations must carry a minimum rating of A-2 by Moody’s or A by S&P. Asset-backed securities must carry a minimum AAA rating by Moody’s and S&P with a maximum average life of two years at the time of purchase.

Interest on the Credit Facility is based on Prime Rate per annum. Because of the Company’s existing cash position and its expected cash flows from operations, the Company chose not to renew the Credit Facility upon its expiration. The Company was charged a weighted average interest rate of 6.5% per annum during the third quarter of 2007 under the Credit Facility. As of September 30, 2007, there was no amount outstanding under the Credit Facility’s Revolver and $0.3 million outstanding under the Credit Facility’s Equipment Loan, with no future availability to draw on the Equipment Loan and payment of the outstanding balance of such Equipment Loan due on or before December 31, 2008.

As of September 30, 2007, total investments in available-for-sale marketable securities were $16.3 million. The Company is subject to financial market risks, including changes in interest rates and the valuations of its investment portfolio. Changes in amounts borrowed or interest rates could impact the Company’s anticipated interest income from interest-bearing cash accounts, or cash equivalents and investments in marketable securities, as well as interest expense on borrowings under the Credit Facility.

Interest rate risk.As of September 30, 2007, virtually all of the investments in the Company’s portfolio were at fixed rates (with a weighted average interest rate of 5.2% per annum). In addition, the Credit Facility’s Equipment Loan is based on a variable interest rate.

To illustrate the potential impact of changes in interest rates, the Company has performed an analysis based on its September 30, 2007 unaudited condensed consolidated balance sheet and assuming no changes in its investment and borrowing structure. Under this analysis, an immediate and sustained 100 basis point increase in the various base rates would result in a decrease in the fair value of the Company’s total portfolio of approximately $72,000 over the next 12 months. An immediate and sustained 100 basis point decrease in the various base rates would result in an increase of the fair value of the Company’s total portfolio of approximately $72,000 over the next 12 months.

ITEM 4. Controls and Procedures

(a) Evaluation of disclosure controls and procedures. The Company carried out an evaluation, under the supervision and with the participation of the Company’s management, including the CEO and the Chief Financial Officer (the “CFO”), of the effectiveness of the design and operation of the Company’s disclosure controls and procedures as of the end of the period covered by this report pursuant to Exchange Act Rule 13a-15. Based on that evaluation, the Company’s management, including the CEO and CFO, concluded that the Company’s disclosure controls and procedures are effective to ensure that information required to be disclosed by the Company in reports that the Company files or submits under the Exchange Act is recorded, processed, summarized and timely reported as specified in the SEC’s rules and forms and accumulated and communicated to the Company’s management, including the CEO and CFO, to allow timely decisions regarding disclosure. It should be noted that the design of any system of controls is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions, regardless of how remote.

(b) Changes in internal control over financial reporting.In connection with the evaluation required by Exchange Act Rule 13a-15, the Company’s management, including the CEO and CFO, concluded that no changes occurred during the quarter ended September 30, 2007 in the Company’s internal control over financial reporting that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

PART II — OTHER INFORMATION

ITEM 2. Unregistered Sales of Equity Securities and Use of Proceeds

Purchases of Equity Securities by the Issuer. On October 30, 2000, the Company announced that its Board authorized the repurchase of up to 1,000,000 shares of the Company’s outstanding Common Stock (the “Stock Repurchase Plan”). For purposes of mitigating the expected dilution created by stock-based compensation, during the first quarter of 2006, the Board authorized the Company to resume repurchasing its Common Stock under the Stock Repurchase Plan. There were 451,790 shares of the Company’s Common Stock repurchased during 2006. As of December 31, 2006, an aggregate of 290,563 shares of Common Stock remained authorized for repurchase under the Stock Repurchase Plan.

On February 6, 2007, the Board extended the Stock Repurchase Plan, authorizing the repurchase of up to 1,000,000 additional shares of the Company’s issued and outstanding Common Stock (the “Increased Shares Authorized”). As a result of the Increased Shares Authorized, there were 1,290,563 shares of Common Stock available for repurchase under the Stock Repurchase Plan as of February 6, 2007. Stock repurchases may be made periodically in the open market, in privately negotiated transactions or in a combination of both. The extent and timing of these repurchase transactions will depend on market conditions and other business considerations.

As of September 30, 2007, the Company had purchased 1,364,375 shares of the Company’s Common Stock under the Stock Repurchase Plan, with 635,625 available for repurchase in the future. The details of Common Stock repurchases for the nine months ended September 30, 2007 were as follows:


					Total Number of Shares		Maximum Number of
					Purchased as Part		Shares That May Yet
	Total Number of		Average Price		Of Publicly Announced		Be Purchased Under the
Period	Shares Purchased (1)		Paid per Share		Plans or Programs		Plans or Programs
January 1 – 31, 2007		—		—		—		1,290,563
February 1 – 28, 2007		62,000		26.79		771,437		1,228,563
March 1 – 31, 2007		103,600		26.37		875,037		1,124,963
April 1 – 30, 2007		—		—		875,037		1,124,963
May 1 – 31, 2007		95,200		27.76		970,237		1,029,763
June 1 – 30, 2007		23,500		28.09		993,737		1,006,263
August 1 – 31, 2007		276,238		29.90		1,269,975		730,025
September 1 – 30, 2007		94,400		31.66		1,364,375		635,625

Total		654,938	$	28.39		1,364,375		635,625


(1)		All shares were purchased through the publicly announced Stock Repurchase Plan in open-market transactions.

ITEM 6. Exhibits


Number		Description

	21.1	Subsidiaries of the Registrant *

	31.1	Certification Pursuant to Rule 13a-14(a) and Rule 15d-14(a) of the Securities Exchange Act of 1934, as amended *

	31.2	Certification Pursuant to Rule 13a-14(a) and Rule 15d-14(a) of the Securities Exchange Act of 1934, as amended *

	32.1	Certification Pursuant to 18 U.S.C. Section 1350, as Adopted
		Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, as amended *

	32.2	Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, as amended *


*		Filed herewith.

Signatures

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.


	The Ultimate Software Group, Inc.
Date: November 8, 2007	By:	/s/ Mitchell K. Dauerman
		Mitchell K. Dauerman
		Executive Vice President, Chief Financial Officer and Treasurer (Authorized Signatory and Principal Financial and Accounting Officer)

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The Ultimate Software Group Inc (ULTI) 10-Q2007 Q3 Quarterly report

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