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Ultimate Software Group 10-Q 2010

Documents found in this filing:

  1. 10-Q
  2. Ex-31.1
  3. Ex-31.2
  4. Ex-32.1
  5. Ex-32.2
  6. Ex-32.2
form_10-q.htm

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, 2010

 
¨
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)
 
(I.R.S. Employer Identification No.)
or organization
   

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. Yes þ  No ¨

Indicate by check mark whether registrant has submitted electronically and posted on its corporate web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding twelve months (or for such period that the registrant was required to submit and post such files).  Yes ¨  No ¨

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

Large accelerated filer  ¨
 
Accelerated filer  þ
     
Non-accelerated filer  ¨
 
Smaller reporting company ¨
(Do not check if a smaller reporting company)
 
Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes ¨ No þ

As of November 1, 2010, there were 25,296,092 shares of the Registrant’s Common Stock, par value $0.01, outstanding.

 
i

 


THE ULTIMATE SOFTWARE GROUP, INC. AND SUBSIDIARIES (“ULTIMATE”)

TABLE OF CONTENTS
   
Page(s)
 
       
     
       
Item 1 – Financial Statements:
     
    1  
    2  
    3  
    4  
    5-10  
         
    11-16  
         
    17  
         
    18  
         
Part II – Other Information:
       
         
    18  
         
    18  
         
    18  
         
    19  
Certifications
    20  


 
ii

 

PART 1 – FINANCIAL INFORMATION
 
Item 1 – Financial Statements
 
THE ULTIMATE SOFTWARE GROUP, INC. AND SUBSIDIARIES
 
UNAUDITED CONDENSED CONSOLIDATED BALANCE SHEETS
 
(In thousands, except share data)
 
             
   
As of
   
As of
 
   
September 30,
   
December 31,
 
   
2010
   
2009
 
ASSETS
           
           
   Cash and cash equivalents
  $ 29,301     $ 23,684  
   Short-term investments in marketable securities
    8,726       8,079  
   Accounts receivable, net of allowance for doubtful accounts of
       $800 and $600 for 2010 and 2009, respectively
    42,792       38,450  
   Prepaid expenses and other current assets
    18,750       15,594  
   Deferred tax assets, net
    1,187       1,128  
      Total current assets before funds held for customers
    100,756       86,935  
   Funds held for customers
    99,539       23,560  
      Total current assets
    200,295       110,495  
Property and equipment, net
    17,831       19,496  
Capitalized software, net
    3,452       4,463  
Goodwill
    3,025       3,198  
Long-term investments in marketable securities
    504       1,444  
Other assets, net
    11,174       12,298  
Long-term deferred tax assets, net
    21,726       19,736  
      Total assets
  $ 258,007     $ 171,130  
LIABILITIES AND STOCKHOLDERS’ EQUITY
               
Current liabilities:
               
   Accounts payable
  $ 5,275     $ 4,476  
   Accrued expenses
    11,650       9,972  
   Current portion of deferred revenue
    63,792       60,980  
   Current portion of capital lease obligations
    2,381       1,897  
      Total current liabilities before customer funds obligations
    83,098       77,325  
   Customer funds obligations
    99,539       23,560  
      Total current liabilities
    182,637       100,885  
Deferred revenue, net of current portion
    6,634       7,579  
Deferred rent
    3,018       3,186  
Capital lease obligations, net of current portion
    2,383       1,710  
      Total liabilities
    194,672       113,360  
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, 28,675,376 and 27,620,384 shares issued in 2010 and 2009, respectively
    287       276  
   Additional paid-in capital
    208,111       184,256  
   Accumulated other comprehensive income (loss)
    76       (696 )
   Accumulated deficit
    (53,699 )     (54,410 )
      154,775       129,426  
Treasury stock, 3,594,825 and 2,985,425 shares, at cost, for 2010 and 2009, respectively
    (91,440 )     (71,656 )
      Total stockholders’ equity
    63,335       57,770  
      Total liabilities and stockholders’ equity
  $ 258,007     $ 171,130  

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,
 
   
2010
   
2009
   
2010
   
2009
 
                       
   Recurring
  $ 44,054     $ 34,092     $ 124,867     $ 97,458  
   Services
    12,796       13,778       41,409       43,100  
   License
    181       252       1,129       3,527  
      Total revenues
    57,031       48,122       167,405       144,085  
                                 
Cost of revenues:
                               
   Recurring
    12,591       9,917       36,043       28,324  
   Services
    11,853       11,586       36,911       34,992  
   License
                150       598  
      Total cost of revenues
    24,444       21,503       73,104       63,914  
Gross profit
    32,587       26,619       94,301       80,171  
Operating expenses:
                               
   Sales and marketing
    14,640       13,049       44,336       39,768  
   Research and development
    10,679       9,763       31,432       28,458  
   General and administrative
    4,849       4,337       15,019       13,207  
      Total operating expenses
    30,168       27,149       90,787       81,433  
      Operating income (loss)
    2,419       (530 )     3,514       (1,262 )
                                 
Other (expense) income:
                               
    Interest expense and other
    (18 )     (19 )     (124 )     (84 )
    Other income, net
    (2 )     30       65       141  
Total other income (expense), net
    (20 )     11       (59 )     57  
Income (loss) from continuing operations before income taxes
    2,399       (519 )     3,455       (1,205 )
   (Provision) benefit for income taxes
    (1,426 )     165       (1,891 )     253  
Income (loss) from continuing operations
  $ 973     $ (354 )   $ 1,564     $ (952 )
   Income (loss) from discontinued operations, net of
                               
      income taxes
    77       (115 )     (853 )     (260 )
Net income (loss)
  $ 1,050     $ (469 )   $ 711     $ (1,212 )
                                 
Basic earnings (loss) per share:
                               
   Earnings (loss) from continuing operations
  $ 0.04     $ (0.02 )   $ 0.06     $ (0.04 )
   Loss from discontinued operations
                (0.03 )     (0.01 )
   Total
  $ 0.04     $ (0.02 )   $ 0.03     $ (0.05 )
                                 
Diluted earnings (loss) per share:
                               
   Earnings (loss) from continuing operations
  $ 0.04     $ (0.02 )   $ 0.06     $ (0.04 )
   Loss from discontinued operations
                (0.03 )     (0.01 )
   Total
  $ 0.04     $ (0.02 )   $ 0.03     $ (0.05 )
                                 
Weighted average shares outstanding:
                               
   Basic
    24,937       24,539       24,844       24,416  
   Diluted
    27,011       24,539       26,951       24,416  
                                 
 
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,
 
   
2010
   
2009
 
Cash flows from operating activities:
           
   Net income (loss)
  $ 711     $ (1,212 )
   Adjustments to reconcile net income (loss) to net cash provided by operating activities:
               
      Depreciation and amortization
    9,044       8,855  
      Provision for doubtful accounts
    1,320       661  
      Non-cash stock-based compensation expense
    10,069       9,912  
      Non-cash realized loss on foreign currency translation adjustment
    912        
      Income taxes
    1,605       (365 )
      Excess tax benefits from stock option exercises
    (3,654 )     ––  
      Changes in operating assets and liabilities:
               
          Accounts receivable
    (5,662 )     2,383  
          Prepaid expenses and other current assets
    (3,156 )     342  
          Other assets
    872       (409 )
          Accounts payable
    799       (2,297 )
          Accrued expenses and deferred rent
    1,510       (2,528 )
          Deferred revenue
    1,867       872  
             Net cash provided by operating activities
    16,237       16,214  
                 
Cash flows from investing activities:
               
   Purchases of marketable securities
    (8,025 )     (7,640 )
   Maturities of marketable securities
    8,323       5,722  
   Net purchases of securities with customer funds
    (75,979 )     (5,367 )
   Capitalized software
          (632 )
   Purchases of property and equipment
    (3,120 )     (3,162 )
             Net cash used in investing activities
    (78,801 )     (11,079 )
                 
Cash flows from financing activities:
               
   Repurchases of Common Stock
    (19,784 )     (7,157 )
   Net proceeds from issuances of Common Stock
    10,786       4,569  
   Excess tax benefits from stock option exercises
    3,654        
   Shares acquired to settle employee tax withholding liabilities
    (645 )      
   Principal payments on capital lease obligations
    (1,838 )     (1,849 )
   Repayments of borrowings of long-term debt
          (320 )
   Net increase in customer fund obligations
    75,979       5,367  
             Net cash provided by financing activities
    68,152       610  
                 
Effect of exchange rate changes on cash
    29       (11 )
Net increase in cash and cash equivalents
    5,617       5,734  
Cash and cash equivalents, beginning of period
    23,684       17,200  
Cash and cash equivalents, end of period
  $ 29,301     $ 22,934  
                 
Supplemental disclosure of cash flow information:
               
   Cash paid for interest
  $ 160     $ 109  
   Cash paid for income taxes
  $ 179     $ 155  
                 
Supplemental disclosure of non-cash financing activities:
               
- Ultimate entered into capital lease obligations to acquire new equipment totaling $3.0 million and $1.6 million for the nine
 
months ended September 30, 2010 and 2009, respectively.
 
- Ultimate entered into an agreement to purchase certain source code from a third-party vendor for $2.0 million, of which
 
$0.5 million was paid during the nine months ended September 30, 2009. There were no payments during the nine months ended
 
September 30, 2010 as this was fully paid as of June 30, 2009.
 

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 (LOSS)
(In thousands)

 
   
Common Stock
   
Additional Paid-in
   
Accumulated Other Comprehensive
   
Accumulated
   
Treasury Stock
   
Total Stockholders’
 
   
Shares
   
Amount
   
Capital
   
Income (Loss)
   
Deficit
   
Shares
   
Amount
   
Equity
 
Balance, December 31, 2009
    27,620     $ 276     $ 184,256     $ (696 )   $ (54,410 )     2,985     $ (71,656 )   $ 57,770  
Net  income
                            711                   711  
Non-cash realized foreign currency translation adjustment
                      912                         912  
Unrealized loss on foreign currency translation adjustments
                      (146 )                       (146 )
Unrealized gain on investments in marketable securities
                      6                         6  
Comprehensive income
                                              1,483  
Issuances of Common Stock from exercises of stock options
    881       9       10,777                               10,786  
Issuances of Common Stock from restricted stock releases
    174       2                                     2  
Shares acquired to settle employee tax withholding liability
                (645 )                             (645 )
Excess tax benefits from stock option exercises
                3,654                                       3,654  
Repurchases of  Common Stock
                                  610       (19,784 )     (19,784 )
Non-cash stock-based compensation
                10,069                               10,069  
                                                                 
Balance, September 30, 2010
    28,675     $ 287     $ 208,111     $ 76     $ (53,699 )     3,595     $ (91,440 )   $ 63,335  

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.           Nature of Operations

The Ultimate Software Group, Inc. and subsidiaries (“Ultimate,” “we,” “us,” or “our”) is a leading provider of unified human capital management software-as-a-service (“SaaS”) solutions for global businesses.  Ultimate’s solutions are marketed as two solution suites, based on company size.  UltiPro Enterprise (“Enterprise”) was designed to address the needs of companies with 1,000 or more employees and UltiPro Workplace (“Workplace”) was designed for companies with fewer than 1,000 employees.  UltiPro is marketed primarily through our Enterprise and Workplace direct sales teams.

2.           Basis of Presentation, Consolidation and the Use of Estimates

The accompanying unaudited condensed consolidated financial statements of Ultimate 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 prepared 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 quarterly report should be read in conjunction with Ultimate’s audited consolidated financial statements and notes thereto included in Ultimate’s Annual Report on Form 10-K for the fiscal year ended December 31, 2009 filed with the SEC on March 5, 2010 (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 Ultimate’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, 2010 and September 30, 2009 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 Ultimate and include its wholly-owned subsidiaries.  Intercompany accounts and transactions have been eliminated in consolidation.

The presentation of the unaudited condensed consolidated statements of operations has been modified to conform with reporting requirements for discontinued operations.  See Note 4 below for further explanation.

 
3.Summary of Significant Accounting Policies and Recent Accounting Pronouncements

Summary of Significant Accounting Policies

Ultimate’s significant accounting policies discussed in Note 3 to its audited consolidated financial statements for the fiscal year ended December 31, 2009, included in the Form 10-K, have not significantly changed.

Recently Issued Accounting Pronouncements

In April 2010, the Financial Accounting Standards Board (“FASB”)  issued Accounting Standards Update (“ASU”) 2010-17, “Revenue Recognition-Milestone Method (Topic 605)” (“ASU 2010-17”).  ASU 2010-17 provides guidance on defining a milestone and determining when the use of the milestone method of revenue recognition for research and development transactions is appropriate.  It provides criteria for evaluating if the milestone is substantive and clarifies that a vendor can recognize consideration that is contingent upon achievement of a milestone as revenue in the period in which the milestone is achieved, if the milestone meets all the criteria to be considered substantive.  ASU 2010-17 is effective prospectively for milestones achieved in fiscal years, and interim periods within those years, beginning on or after June 15, 2010.  Early adoption is permitted.  If a company elects early adoption and the period of adoption is not the beginning of its fiscal year, the requirements must be applied retrospectively to the beginning of the fiscal year.  We do not believe the adoption of ASU 2010-17 will have a material impact on our unaudited condensed consolidated financial statements.

In October 2009, the FASB issued ASU 2009-13 (EITF 08-1), “Multiple-Deliverable Revenue Arrangements” (“ASU 2009-13 (EITF 08-1)”).  ASU 2009-13 (EITF 08-1) amends Accounting Standards Codification (“ASC”) Subtopic 605-25, “Revenue Recognition-Multiple-Element Arrangements” (“ASC Subtopic 605-25”), which sets forth requirements that must be met for an entity to recognize revenue from the sale of a delivered item that is part of a multiple-element arrangement when other items have not yet been delivered.

ASC Subtopic 605-25 requires that there be objective and reliable evidence of the standalone selling price of the undelivered items which must be supported by either vendor-specific objective evidence (“VSOE”) or third-party evidence (“TPE”).

 
ASU 2009-13 (EITF 08-1) will eliminate the requirement that all undelivered elements have VSOE or TPE before an entity can recognize the portion of an overall arrangement fee that is attributable to items that already have been delivered.  In the absence of VSOE or TPE of the standalone selling price for one or more delivered or undelivered elements in a multiple-element arrangement, entities will be required to estimate the selling prices of those elements.  The overall arrangement fee will be allocated to each element (both delivered and undelivered items) based on their relative selling prices, regardless of whether those selling prices are evidenced by VSOE or TPE or are based on the entity’s estimated selling price.  Application of the “residual method” of allocating an overall arrangement fee between delivered and undelivered elements will no longer be permitted upon adoption of ASU 2009-13 (EITF 08-1).  Additionally, the new guidance will require entities to disclose more information about their multiple-element revenue arrangements.  ASU 2009-13 (EITF 08-1) is effective prospectively for revenue arrangements entered into or materially modified in fiscal years beginning on or after June 15, 2010.  Early adoption is permitted.  If a company elects early adoption and the period of adoption is not the beginning of its fiscal year, the requirements must be applied retrospectively to the beginning of the fiscal year.  We are evaluating the impact of ASU 2009-13 (EITF 08-1) and do not believe the adoption of ASU 2009-13 (EITF 08-1) will have a material impact on our consolidated financial statements.
 
4.          Discontinued Operations

During the nine months ended September 30, 2010, Ultimate discontinued the operations of The Ultimate Software Group UK Limited, our wholly-owned subsidiary in the United Kingdom (the “UK Subsidiary”).  Discontinued operations, net of income taxes, resulted in income of $0.1 million for the three months ended September 30, 2010.  The loss from discontinued operations, net of income taxes, of $0.9 million for the nine months ended September 30, 2010, was principally from the realization of a non-cash foreign currency translation adjustment.  The discontinuation of the operations of the UK Subsidiary was completed as of September 30, 2010.

The financial results of discontinued operations of the UK Subsidiary are as follows (in thousands):

   
For the Three Months
   
For the Nine Months
 
   
Ended September 30,
   
Ended September 30,
 
   
2010
   
2009
   
2010
   
2009
 
                         
Total revenues
  $ 3     $ 74     $ 51     $ 234  
                                 
                                 
Pretax loss from UK Subsidiary operations
  $ (26 )   $ (175 )   $ (85 )   $ (372 )
Loss from disposal of UK Subsidiary (for foreign
                               
   currency translation adjustment)
    (26 )           (912 )      
Pretax loss from discontinued operations
    (52 )     (175 )     (997 )     (372 )
Income tax benefit
    129       60       144       112  
Income (loss) from discontinued operations, net of
                               
   income taxes
  $ 77     $ (115 )   $ (853 )   $ (260 )
                                 

The assets and liabilities of the UK Subsidiary were immaterial, both individually and in the aggregate, and, therefore, are not presented separately in the unaudited condensed financial statements and notes thereto.

5.           Investments in Marketable Securities and Fair Value of Financial Instruments

We classify our investments in marketable securities with readily determinable fair values 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 gains and losses on available-for-sale securities are reported as a net amount in accumulated other comprehensive income or loss in stockholders’ equity until realized.  Gains and losses on the sale of available-for-sale securities are determined using the specific identification method.  Included in accumulated other comprehensive income (loss) was $11 thousand and $6 thousand of unrealized gains on available-for-sale securities at September 30, 2010 and December 31, 2009, respectively.

The amortized cost, net unrealized gain and fair value of our investments in marketable available-for-sale securities as of September 30, 2010 and December 31, 2009 are shown below (in thousands):

 
   
As of September 30, 2010
   
As of December 31, 2009
 
         
Net
               
Net
       
   
Amortized
   
Unrealized
   
Fair
   
Amortized
   
Unrealized
   
Fair
 
   
Cost
   
Gain
   
Value
   
Cost
   
Gain
   
Value
 
                                     
Corporate debentures – bonds
  $ 3,198     $ 8     $ 3,206     $ 3,025     $ 3     $ 3,028  
Commercial paper
    1,798             1,798       1,499             1,499  
Agency bonds
    1,923       1       1,924       1,407       1       1,408  
International government
                                               
    bond
    303             303                    
U.S. Treasury bills
                      1,995       2       1,997  
U.S. Treasury bonds
    1,506       3       1,509       501             501  
Certificates of deposit
    490             490       1,090             1,090  
Total investments
  $ 9,218     $ 12     $ 9,230     $ 9,517     $ 6     $ 9,523  

 
The amortized cost and fair value of the marketable available-for-sale securities by contractual maturity as of September 30, 2010 are shown below (in thousands):

   
As of September 30, 2010
 
   
Amortized
   
Fair
 
   
Cost
   
Value
 
             
Due in one year or less
  $ 8,716     $ 8,726  
Due after one year
    502       504  
Total
  $ 9,218     $ 9,230  

We classify and disclose fair value measurements in one of the following three categories of the fair value hierarchy:

 
Level 1:
Unadjusted quoted prices in active markets that are accessible at the measurement date for identical, unrestricted assets and liabilities.
 
Level 2:
Quoted prices in markets that are not active or financial instruments for which all significant inputs are observable, either directly or indirectly.
 
Level 3:
Prices or valuations that require inputs that are both significant to the fair value measurement and unobservable.

A financial instrument’s level within the fair value hierarchy is based on the lowest level of any input that is significant to the fair value measurment.

Our assets that are measured by management at fair value on a recurring basis are generally classified within Level 1 or Level 2 of the fair value hierarchy.  We did not have available-for-sale securities within Level 3 as of September 30, 2010 and December 31, 2009.  The types of instruments valued based on quoted market prices in active markets include most money market securities and certificates of deposit.  Such instruments are generally classified within Level 1 of the fair value hierarchy.   We did not have any significant transfers into and out of Level 1 and Level 2 during the nine months ended September 30, 2010 and the twelve months ended December 31, 2009.

The types of instruments valued by management, based on quoted prices in less active markets, broker or dealer quotations, or alternative pricing sources with reasonable levels of price transparency, include Ultimate’s corporate debentures and bonds, commercial paper, agency bonds, international government bond and U.S. Treasury bills and bonds.  Such instruments are generally classified within Level 2 of the fair value hierarchy.  Ultimate uses consensus pricing, which is based on multiple pricing sources, to value its fixed income investments.

The following table sets forth, by level within the fair value hierarchy, financial assets accounted for at fair value as of September 30, 2010 and December 31, 2009 (in thousands):

   
As of September 30, 2010
   
As of December 31, 2009
 
         
Quoted
               
Quoted
       
         
Prices in
   
Other
         
Prices in
   
Other
 
         
Active
   
Observable
         
Active
   
Observable
 
         
Markets
   
Inputs
         
Markets
   
Inputs
 
   
Total
   
(Level 1)
   
(Level 2)
   
Total
   
(Level 1)
   
(Level 2)
 
Corporate debentures-bonds
  $ 3,206           $ 3,206     $ 3,028     $     $ 3,028  
Commercial paper
    1,798             1,798       1,499             1,499  
Agency bonds
    1,924             1,924       1,408             1,408  
International government bond
    303               303       –        –        –   
U.S. Treasury bills
                      1,997             1,997  
U.S.Treasury bonds
    1,509             1,509       501             501  
Certificates of deposit
    490       490             1,090       1,090        
Total
  $ 9,230     $ 490     $ 8,740     $ 9,523     $ 1,090     $ 8,433  

Financial assets and liabilities measured at fair value on a recurring basis were presented in the unaudited condensed consolidated balance sheet as of September 30, 2010 and in the audited consolidated balance sheet as of December 31, 2009 as short-term and long-term investments in marketable securities.  There were no financial liabilities accounted for at fair value as of September 30, 2010 and December 31, 2009.
 

 
 
6.              Property and Equipment

Property and equipment are stated at cost, net of accumulated depreciation and amortization. Property and equipment are depreciated using the straight-line method over the estimated useful lives of the assets, which range from two to fifteen years. Leasehold improvements and assets under capital leases are amortized over the shorter of the estimated useful life of the asset or the term of the lease, which range from three 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 as of September 30, 2010 and December 31, 2009 consisted of the following (in thousands):

   
As of September 30,
2010
   
As of December 31,
 2009
 
Property and equipment
  $ 78,691     $ 72,717  
Less:  accumulated depreciation and amortization
    60,860       53,221  
    $ 17,831     $ 19,496  

7. Earnings Per Share

Basic earnings per share is computed by dividing net 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 potentially dilutive common shares had been issued.  Due to the discontinued operations of the UK Subsidiary, income from continuing operations was used in determining whether potential common shares are dilutive or anti-dilutive.  For the three and nine months ended September 30, 2010, potential common shares were dilutive due to income from continuing operations.  For the three and nine months ended September 30, 2009, potential common shares were anti-dilutive due to a loss from continuing operations.

The following is a reconciliation of the common shares used in the computation of basic and diluted earnings (loss) per share for the three and nine months ended September 30, 2010 and 2009 (in thousands):
 

   
For the Three Months
Ended September 30,
   
For the Nine Months
ended September 30,
 
   
2010
   
2009
   
2010
   
2009
 
Basic weighted average common shares outstanding
    24,937       24,539       24,844       24,416  
Effect of dilutive equity instruments
    2,074             2,107        
Dilutive weighted average common shares outstanding
    27,011       24,539       26,951       24,416  
                                 
Options to purchase shares of common stock and other stock-based                                
 awards outstanding which are not included in the calculation of diluted                                
 earnings (loss) per share because their impact is anti-dilutive     56        6,074        55        6,264   
                               


8.           Comprehensive Income (Loss)

Comprehensive income (loss) represents all changes in equity that result from transactions and other economic events in a period other than transactions with owners. Accumulated other comprehensive income (loss), as presented in 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 income tax.

For the three and nine months ended September 30, 2010, we realized a non-cash foreign currency translation adjustment for the discontinued operations of our UK Subsidiary.  This was recorded in discontinued operations and represents the reclassification of prior period net unrealized losses from other comprehensive income (loss).  There was no foreign currency translation adjustment for the three and nine months ended September 30, 2009.

Comprehensive income (loss) for the three and nine months ended September 30, 2010 and 2009 was as follows (in thousands):

 

   
For the Three Months
ended September 30,
   
For the Nine Months
ended September 30,
 
   
2010
   
2009
   
2010
   
2009
 
Net income (loss) (1)
  $ 1,050     $ (469 )   $ 711     $ (1,212 )
    Other comprehensive income (loss)
                               
        Realized foreign currency translation
                               
             adjustment
    26             912        
        Unrealized gain (loss) on investments in
                               
             marketable securities available-for-sale
    8       (3 )     6       (4 )
        Unrealized gain (loss) on foreign currency
                               
             translation adjustments
    32       (117 )     (146 )     278  
Comprehensive income (loss)
  $ 1,116     $ (589 )   $ 1,483     $ (938 )

(1)  
Pursuant to applicable accounting rules, the amount attributable to the UK Subsidiary and accumulated in the translation adjustment component of equity became realized in the unaudited condensed consolidated statements of operations during the three and nine months ended September 30, 2010, the periods in which discontinuation of the operations for the UK Subsidiary was completed.
 
 
9.           Foreign Currency

The financial statements of Ultimate’s foreign subsidiaries have been translated into U.S. dollars.  The functional currency of our wholly-owned subsidiary, The Ultimate Software Group of Canada, Inc., is the Canadian dollar and the functional currency of the UK Subsidiary is the British pound.  Assets and liabilities are translated into U.S. dollars at period-end exchange rates.  Income and expenses are translated at the average exchange rate for the reporting period.  The resulting non-cash foreign currency translation adjustments, representing unrealized gains or losses, are included in unaudited condensed consolidated stockholders’ equity as a component of accumulated other comprehensive income (loss).  Realized gains and losses resulting from foreign exchange transactions are included in total operating expenses in the unaudited condensed consolidated statements of operations. For the three and nine months ended September 30, 2010, Ultimate had a realized foreign currency translation loss of $26 thousand and $0.9 million, respectively, included in income (loss) from discontinued operations for its UK Subsidiary.  There was no realized foreign currency translation gain or loss from discontinued operations for the three and nine months ended September 30, 2009. For the three months ended September 30, 2010, Ultimate had cumulative unrealized foreign currency translation gains of $59 thousand.  For the nine months ended September 30, 2010, Ultimate had a cumulative unrealized foreign currency translation loss of $146 thousand. For the three months ended September 30, 2009, Ultimate had a cumulative unrealized foreign currency translation loss of $117 thousand and for the nine months ended September 30, 2009, Ultimate had cumulative unrealized foreign currency translation gains of $278 thousand.  Included in accumulated other comprehensive income (loss), as presented in the accompanying unaudited condensed consolidated balance sheets, is $65 thousand of unrealized foreign currency translation gains at September 30, 2010 and $0.7 million in unrealized foreign currency translation losses at December 31, 2009.

10.           Stock-Based Compensation

Our Amended and Restated 2005 Equity and Incentive Plan (the “Plan”) authorizes the grant of options (“Options”) to non-employee directors, officers and employees of Ultimate to purchase shares of Ultimate’s common stock, par value $0.01 per share (“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, the “Awards”).  Prior to the adoption of the Plan, options to purchase shares of Common Stock were issued under Ultimate’s Nonqualified Stock Option Plan (the “Prior Plan”).

As of September 30, 2010, the aggregate number of shares of Common Stock authorized under the Plan and the Prior Plan was 12,500,000 and the aggregate number of shares of Common Stock that were available to be issued under all Awards granted under the Plan was 1,012,592 shares.

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



   
For the Three Months
Ended September 30,
   
For the Nine Months
Ended September 30,
 
   
2010
   
2009
   
2010
   
2009
 
Non-cash stock-based compensation expense:
                       
   Cost of recurring revenues
  $ 228     $ 170     $ 669     $ 506  
   Cost of services revenues
    284       326       947       994  
   Sales and marketing
    1,743       1,776       5,104       5,311  
   Research and development
    269       316       937       926  
   General and administrative
    820       735       2,412       2,175  
  Total non-cash stock-based compensation expense
  $ 3,344     $ 3,323     $ 10,069     $ 9,912  


Net cash proceeds from the exercise of stock options were $5.9 million and $10.8 million for the three and nine months ended September 30, 2010, respectively, and $2.9 million and $4.6 million for the three and nine months ended September 30, 2009, respectively. There was a $2.7 million and $3.7 million income tax benefit recognized in additional paid in capital from the realization of excess stock-based payment deductions during the three and nine months ended September 30, 2010, respectively.  There was no income tax benefit recognized from stock option exercises during the three and nine months ended September 30, 2009.
 
Stock Option, Restricted Stock and Restricted Stock Unit Activity

There were no stock options granted during the nine months ended September 30, 2010.  The following table summarizes stock option activity (for previously granted stock options) for the nine months ended September 30, 2010 (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, 2009
    4,165     $ 17.79       5.55     $ 49,687  
  Granted
                           
  Exercised
    (881 )     12.24                  
  Forfeited or expired
    (19 )     27.18                  
Outstanding at September 30, 2010
    3,265     $ 19.24       5.24     $ 63,334  
                                 
Exercisable at September 30, 2010
    3,028     $ 18.56       5.07     $ 60,807  
 
 
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 Ultimate’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, 2010.  The amount of the aggregate intrinsic value changes based on the fair value of Ultimate’s Common Stock.  Total intrinsic value of options exercised was $9.7 million and $18.9 million for the three and nine months ended September 30, 2010, respectively, and $5.4 million and $7.6 million for the three and nine months ended September 30, 2009, respectively.  Total fair value of options vested during the three and nine months ended September 30, 2010 was $1.1 million and $4.0 million, respectively, and $1.5 million and $5.2 million during the three and nine months ended September 30, 2009, respectively.

As of September 30, 2010, $1.2 million of total unrecognized compensation costs related to non-vested stock options is expected to be recognized over a weighted average period of 0.56 years.

During the three months ended September 30, 2010 and September 30, 2009, we granted restricted stock Awards for 8,125 shares and 8,565 shares, respectively, of Common Stock to non-employee directors.  There were 23,625 and 28,750 restricted stock unit Awards granted to employees during the three months ended September 30, 2010 and September 30, 2009, respectively.  During the three months ended September 30, 2010 and September 30, 2009, there were no shares of Common Stock previously issued under restricted stock Awards that became vested.  During the three months ended September 30, 2010, 8,471 shares became payable under restricted stock unit Awards that vested during such period.  2,793 of such shares were retained by Ultimate and not issued, in satisfaction of withholding tax requirements applicable to payment of such Awards, and 5,678 of such shares were issued to the holders of such Awards.  No restricted stock unit Awards became vested and no payments were made under restricted stock unit Awards during the three months ended September 30, 2009.

The following table summarizes restricted stock and restricted stock unit activity for the nine months ended September 30, 2010 (in thousands, except per share amounts):


   
Restricted Stock Awards
   
Restricted Stock Unit Awards
 
         
Weighted
       
         
Average
       
         
Grant Date
       
   
Shares
   
Fair Value
   
Shares
 
Outstanding at December 31, 2009
    1,405     $ 24.36       247  
  Granted
    25       31.81       179  
  Released
    (105 )     21.60       (91 )
  Forfeited or expired
                (10 )
Outstanding at September 30, 2010
    1,325     $ 24.72       325  

As of September 30, 2010, $12.4 million of total unrecognized compensation costs related to non-vested restricted stock Awards were expected to be recognized over a weighted average period of 1.60 years.  As of September 30, 2010, $6.4 million of total unrecognized compensation costs related to non-vested restricted stock unit Awards were expected to be recognized over a weighted average period of 1.96 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. and subsidiaries (“Ultimate,” “we,” “us,” or “our”) 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 (the “Form 10-Q”) and in Ultimate’s Annual Report on Form 10-K for the fiscal year ended December 31, 2009 filed with the Securities and Exchange Commission (the “SEC”) on March 5, 2010 (the “Form 10-K”).

Ultimate’s significant accounting policies discussed in Note 3 to its audited consolidated financial statements for the fiscal year ended December 31, 2009, included in the Form 10-K, have not significantly changed.

Overview

Ultimate is a leading provider of unified human capital management (“HCM”) software-as-a-service (“SaaS”) solutions for global businesses.

Ultimate’s UltiPro software (“UltiPro”) is a comprehensive Internet-based solution delivered primarily as an online service and 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 onboarding, HCM and compliance, benefits management and online enrollment, payroll, performance management, salary planning and budgeting for compensation management, reporting and analytical decision-making tools, time and attendance, and a self-service Web portal for executives, managers, administrators, and employees.

Our SaaS offering of UltiPro (the “SaaS Offering”) provides online access to comprehensive HCM functionality for organizations that want to simplify the information technology (“IT”) support requirements of their business applications. We have found that our SaaS Offering is attractive to companies that want to focus on their core competencies to increase sales and profits. Through the SaaS Offering, we supply and manage the hardware, infrastructure, ongoing maintenance and backup services for our customers.  Customer systems are managed at three data centers, one located in the Miami, Florida area, one in the Atlanta, Georgia area, and another in Toronto, Canada. All data centers are owned and operated by independent third parties.

UltiPro is marketed as two solution suites, based on company size.  UltiPro Enterprise (“Enterprise”) was designed to address the needs of companies with 1,000 or more employees and is delivered primarily through SaaS but is also available as an on-premise solution.  UltiPro Workplace (“Workplace”) was designed for companies with fewer than 1,000 employees and is delivered exclusively through SaaS.  UltiPro Workplace provides medium-sized and smaller companies with nearly all the features that larger Enterprise companies have with UltiPro, plus a bundled services package. Since many companies in this market do not have IT staff on their premises to help with system issues, UltiPro Workplace is designed to give these customers a high degree of convenience by handling system setup, business rules, and other situations for customers “behind the scenes.”  UltiPro is marketed primarily through Ultimate’s Enterprise and Workplace direct sales teams.

In addition to UltiPro’s core HCM functionality, Ultimate’s customers have the option to purchase a number of additional features on a per-employee-per-month (or “PEPM”) basis, which are available to enhance the functionality of UltiPro’s core features and which are based on the particular business needs of the customers.  These optional UltiPro features currently include (i) the talent management suite of products (recruitment, onboarding, performance management, salary planning and budgeting for compensation management, and employee relations tools for managing disciplinary actions, grievances, and succession planning); (ii) benefits enrollment; (iii) time, attendance and scheduling; (iv) time management, (v) tax filing; (vi) wage attachments; and (vii) other optional features (collectively, “Optional Features”). All Optional Features are individually priced solely on a subscription basis.  Some of the Optional Features are available to both Enterprise and Workplace customers while others are available exclusively to either Enterprise or Workplace customers, and availability is based on the needs of the respective customer types, including the number of their employees and the complexity of their HCM environment.

The key drivers of our business are (i) growth in recurring revenues; (ii) the retention of the underlying customers, once our solutions are sold (“Customer Retention”) and (iii) management’s control of operating expense growth.  For the quarter ended September 30, 2010, our (i) recurring revenues grew by 29% compared with the same quarter last year, (ii) our Customer Retention was 96%, on a trailing twelve-month basis, and (iii) operating expenses grew by 11.1% compared with the same quarter last year.

Ultimate has two primary revenue sources:  recurring revenues and services revenues.  Revenues from our SaaS Offering and maintenance revenues are the primary components of recurring revenues.  The majority of services revenues are derived from implementation services.

Effective April 1, 2009, Ultimate discontinued selling its on-site UltiPro solutions to new customers on a perpetual license basis, although we continue to sell on-site UltiPro solutions on a subscription basis (priced and billed to customers on a PEPM basis). We sell licenses to existing license customers but only in relation to the customer’s employee growth or for Optional Features if they already have a perpetual license for the on-site UltiPro solutions.  As perpetual license agreements were sold, annual maintenance contracts (priced as a percentage of the related license fee) accompanied those agreements.  Maintenance contracts typically have a one-year term with annual renewal periods thereafter.  We have historically maintained a steady Customer Retention rate for our renewal maintenance agreements and do not believe our decision to discontinue new sales of perpetual license agreements will materially affect our future maintenance revenues (as they relate to existing license customers).
 

 
 
As SaaS units are sold, the recurring revenue backlog associated with the SaaS Offering grows, enhancing the predictability of future revenue streams.  SaaS sales of UltiPro include ongoing monthly subscription fees, priced on a PEPM basis, and, to a lesser extent, a one-time upfront (or setup) fee, priced on a per-employee basis.  Revenue recognition for the SaaS Offering is triggered when the related customer processes its first payroll (or goes “Live”).  When a SaaS customer goes Live, we begin recognizing the associated ongoing monthly PEPM fees and the related upfront fees are recognized as recurring subscription revenues ratably over the term of the related contract (typically 24 months).

During the nine months ended September 30, 2010, Ultimate discontinued the operations of The Ultimate Software Group UK Limited, our wholly-owned subsidiary in the United Kingdom.  Loss from discontinued operations, net of income taxes, for the nine months ended September 30, 2010, was principally comprised of $0.9 million from the realization of a non-cash foreign currency translation adjustment.
 
 
Critical Accounting Estimates

The preparation of financial statements in conformity with U.S. generally accepted accounting principles (“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.  Ultimate’s critical accounting estimates, as discussed in Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations, included in the Form 10-K, have not significantly changed.

Results of Operations

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

   
For the Three Months
   
For the Nine Months
 
   
Ended September 30,
   
Ended September 30,
 
   
2010
   
2009
   
2010
   
2009
 
Revenues:
                       
Recurring
    77.3 %     70.9 %     74.6 %     67.6 %
Services
    22.4       28.6       24.7       29.9  
License
    0.3       0.5       0.7       2.5  
Total revenues
    100.0       100.0       100.0       100.0  
Cost of revenues:
                               
Recurring
    22.1       20.6       21.6       19.7  
Services
    20.7       24.1       22.0       24.3  
License
                0.1       0.4  
Total cost of revenues
    42.8       44.7       43.7       44.4  
Operating expenses:
                               
Sales and marketing
    25.7       27.1       26.5       27.6  
Research and development
    18.7       20.3       18.8       19.7  
General and administrative
    8.5       9.0       8.9       9.2  
Total operating expenses
    52.9       56.4       54.2       56.5  
Operating income (loss)
    4.3       (1.1 )     2.1       (0.9 )
Other income (expense):
                               
      Interest expense and other
                (0.1 )      
      Other income, net
                      0.1  
Total other income (expense), net
                (0.1 )     0.1  
Income (loss) from continuing operations
                               
   before income taxes
    4.3       (1.1 )     2.0       (0.8 )
      (Expense) benefit for income taxes
    (2.5 )     0.3       (1.1 )     0.2  
Income (loss) from continuing operations
    1.8       (0.8 )     0.9       (0.6 )
Loss from discontinued operations,
                               
   net of taxes
          (0.2 )     (0.5 )     (0.2 )
Net income (loss)
    1.8 %     (1.0 ) %     0.4 %     (0.8 ) %

Revenues

Our revenues are derived from recurring revenues and services revenues and, to a lesser extent, license revenues.  There have been no material changes to our significant accounting policies from those described in our Form 10-K.

Total revenues, consisting of recurring, services and license revenues, increased 18.5% to $57.0 million for the three months ended September 30, 2010 from $48.1 million for the three months ended September 30, 2009, and 16.2% to $167.4 million for the nine months ended September 30, 2010 from $144.1 million for the nine months ended September 30, 2009.

 
 
Recurring revenues increased 29.2 % to $44.1 million for the three months ended September 30, 2010 from $34.1 million for the three months ended September 30, 2009, and 28.1% to $124.9 million for the nine months ended September 30, 2010 from $97.5 million for the nine months ended September 30, 2009. The increases for the three and nine months ended September 30, 2010 were primarily due to an increase in revenues from our SaaS Offering.  Revenues from our SaaS Offering increased 39.2% and 40.3% for the three and nine months ended September 30, 2010, respectively, in comparison to the same periods in 2009. The increases were based on the revenue impact of incremental units sold that have gone Live since September 30, 2009, including UltiPro and, to a lesser extent, Optional Features of UltiPro.  Recognition of recurring subscription revenues from sales of our SaaS Offering begins when the related customer goes Live.

Services revenues decreased 7.1% to $12.8 million for the three months ended September 30, 2010 from $13.8 million for the three months ended September 30, 2009 and 3.9% to $41.4 million for the nine months ended September 30, 2010 from $43.1 million for the nine months ended September 30, 2009. The decreases for the three and nine months ended September 30, 2010 were mainly due to (i) less billable hours from fewer Ultimate revenue-generating consultants for Enterprise sales and (ii) a decrease in the Enterprise blended net rate per hour, partially offset by (iii) higher implementation revenues recognized for Workplace sales.

 License revenues decreased 28.2% to $0.2 million for the three months ended September 30, 2010, from $0.3 million for the three months ended September 30, 2009. For the nine months ended September 30, 2010, license revenues decreased 68.0% to $1.1 million from $3.5 million for the nine months ended September 30, 2009.  Effective April 1, 2009, Ultimate discontinued selling its on-site UltiPro solutions to new customers on a perpetual license basis, although we continue to sell on-site UltiPro solutions on a subscription basis (priced and billed to customers on a PEPM basis).  However, we did sell licenses of Optional Features to existing license customers during the first nine months of 2010.

Cost of Revenues

Cost of revenues primarily consists of the costs of recurring and services revenues. Cost of recurring revenues primarily consists of the cost of maintenance (which includes technical support to Ultimate’s customers and the cost of providing periodic updates) and the cost of recurring subscription revenues (“SaaS costs”), including amortization of capitalized software. Cost of services revenues primarily consists of costs to provide implementation services to Ultimate’s customers.

Total cost of revenues increased 13.7% to $24.4 million for the three months ended September 30, 2010 from $21.5 million for the three months ended September 30, 2009 and 14.4% to $73.1 million for the nine months ended September 30, 2010 from $63.9 million for the nine months ended September 30, 2009.

Cost of recurring revenues increased 27.0% to $12.6 million for the three months ended September 30, 2010 from $9.9 million for the three months ended September 30, 2009 and 27.3% to $36.0 million for the nine months ended September 30, 2010 from $28.3 million for the nine months ended September 30, 2009. The $2.7 million and $7.7 million increases in cost of recurring revenues for the three and nine months ended September 30, 2010, respectively, were primarily due to increases in both maintenance costs and SaaS costs.  Customer support and maintenance costs increased primarily due to higher labor costs commensurate with the growth in Ultimate’s recurring revenues customer base.  SaaS costs increased principally as a result of increased labor costs to support the growth in sales from our SaaS Offering.

Cost of services revenues increased 2.3% to $11.9 million for the three months ended September 30, 2010 from $11.6 million for the three months ended September 30, 2009, and 5.5% to $36.9 million for the nine months ended September 30, 2010 from $35.0 million for the nine months ended September 30, 2009. The increases for the three and nine months ended September 30, 2010 were primarily due to an increase in labor costs from Workplace implementation services as we continued to build the infrastructure for Workplace to support the growth in related sales.
 
Sales and Marketing

Sales and marketing expenses consist primarily of salaries and benefits, sales commissions and travel and promotional expenses, as well as advertising and marketing costs. Sales and marketing expenses increased 12.2% to $14.6 million for the three months ended September 30, 2010 from $13.0 million for the three months ended September 30, 2009, and 11.5% to $44.3 million for the nine months ended September 30, 2010 from $39.8 million for the nine months ended September 30, 2009. The increases in sales and marketing expenses for the three and nine month periods ended September 30, 2010 were primarily due to increased labor and related costs and higher sales commissions principally related to increased recurring subscription revenues from our SaaS Offering for both Enterprise and Workplace. Commissions on SaaS sales are amortized over the initial contract term (typically 24 months) commencing on the Live date, which corresponds to the revenue recognition for SaaS sales.

Research and Development
 
Research and development expenses consist primarily of software development personnel costs.  Research and development expenses increased 9.4% to $10.7 million for the three months ended September 30, 2010 from $9.8 million for the three months ended September 30, 2009, and 10.5% to $31.4 million for the nine months ended September 30, 2010 from $28.5 million for the nine months ended September 30, 2009, principally due to higher labor costs related to the ongoing development of core UltiPro and Optional Features and, to a lesser extent, higher third-party consulting costs.
 
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 increased 11.8% to $4.8 million for the three months ended September 30, 2010 from $4.3 million for the three months ended September 30, 2009 and increased 13.7% to $15.0 million for the nine months ended September 30, 2010 from $13.2 million for the nine months ended September 30, 2009.  The increases in general and administrative expenses were primarily due to higher labor and related costs and, to a lesser extent, an increase in the provision for doubtful accounts.
 
 
Income Taxes

Income taxes, related to continuing operations, for the three months ended September 30, 2010 and September 30, 2009 included a consolidated provision of $1.4 million and a consolidated benefit of $0.2 million, respectively.  Income taxes, related to continuing operations, for the nine months ended September 30, 2010 and September 30, 2009 included a consolidated provision of $1.9 million and a consolidated benefit of $0.3 million, respectively.  The effective income tax rate related to continuing operations for the three months ended September 30, 2010 and September 30, 2009 was 59.4% and 31.8%, respectively.  The effective income tax rate related to continuing operations for the nine months ended September 30, 2010 and September 30, 2009 was 54.7% and 21.0%, respectively.  The variation in tax rates for the 2010 periods from the 2009 periods was primarily attributable to the proportional relationship of net permanent differences to the pre-tax net income for the 2010 periods, increasing the tax expense and rate, and the pre-tax net loss for the 2009 periods, decreasing the tax benefit and rate.

Net operating loss carryforwards, available to offset future taxable income, related to continuing operations at December 31, 2009 were approximately $83.0 million and $0.3, for Federal and foreign income tax reporting purposes, respectively.  Approximately $83.0 million of the total Federal and foreign net operating loss carryforwards was attributable to deductions from the exercise of non-qualified stock options and the vesting of restricted stock units and restricted stock Awards (“Stock Based Compensation Deductions”) of our employees and non-employee directors.  The benefit from the Stock Based Compensation Deductions will primarily be credited to paid-in capital and deferred tax assets when realized.  Such carryforwards expire from 2011 through 2029.  Utilization of such carryforwards may be limited as a result of cumulative ownership changes in Ultimate’s equity instruments.

The balance of deferred tax assets, net of deferred tax liabilities, was $22.9 million as of September 30, 2010.  If estimates of taxable income are decreased, a valuation allowance may need to be provided for some or all deferred tax assets, which will cause an increase in income tax expense.

Loss from Discontinued Operations

We had income from discontinued operations, net of income taxes, for the three months ended September 30, 2010 of $77 thousand.  Loss from discontinued operations, net of income taxes, for the nine months ended September 30, 2010, was $853 thousand.  The income from discontinued operations, net of income taxes, for the three and nine months ended September 30, 2010, was comprised of $103 thousand and $59 thousand, respectively, from subsidiary operations and a $26 thousand loss and a $912 thousand loss, respectively, from the realization of a non-cash foreign currency translation adjustment.  The net loss from discontinued operations, net of income taxes, for the three and nine months ended September 30, 2009, was $115 thousand and $260 thousand, respectively.  There was no realized foreign currency translation adjustment for the three and nine months ended September 30, 2009.

Liquidity and Capital Resources

In recent years, Ultimate has funded operations from cash flows generated from operations and, to a lesser extent, equipment financing and borrowing arrangements.

As of September 30, 2010, we had $38.5 million in cash, cash equivalents and total investments in marketable securities, reflecting a net increase of $5.3 million since December 31, 2009.
The $5.3 million net increase was primarily due to cash provided by operations of $16.2 million and excess tax benefits from stock option exercises, net of shares acquired to settle employee tax withholding liabilities of $3.0 million, partially offset by purchases of treasury stock, net of proceeds from the issuance of Common Stock from employee stock option exercises, of $9.0 million and cash purchases of property and equipment (including principal payments on financed equipment) of $5.0 million.

Net cash provided by operating activities for the nine months ended September 30, 2010 of $16.2 million was comparable to that for the nine  months ended September 30, 2009.  For the nine months ended September 30, 2010 compared with the nine months ended September 30, 2009, accrued expenses and deferred rent increased by $4.0 million, accounts payable increased by $3.1 million and cash provided by operations was higher by $5.8 million.  These increases were offset by increased accounts receivable of $7.1 million, excess tax benefits from stock option exercises of $3.7 million and higher prepaid expenses and other current assets of $3.5 million.

Net cash used in investing activities was $78.8 million for the nine months ended September 30, 2010 as compared to $11.1 million for the nine months ended September 30, 2009.  The increase of $67.7 million was primarily attributable to an increase of $70.6 million in funds received from and held on behalf of Ultimate’s customers using the UltiPro tax filing offering (“UltiPro Tax Filing Customer Funds”), with such funds being invested by us in overnight repurchase agreements backed by U.S. Treasury or U.S. Government Agency securities and an increase of $0.4 million in cash purchases of marketable securities, partially offset by an increase in cash provided from the maturities of marketable securities of $2.6 million and, to a lesser extent, a decrease in capitalized software costs of $0.6 million.

Net cash provided by financing activities was $68.2 million for the nine months ended September 30, 2010 as compared to $0.6 million for the nine months ended September 30, 2009. The $67.6 million increase was primarily related to an increase of $70.6 million in UltiPro Tax Filing Customer Funds received, a $6.2 million increase in proceeds from the issuance of Common Stock from employee and non-employee director stock option exercises and excess tax benefits from stock option exercises of $3.7 million, partially offset by a $12.6 million increase in repurchases of Common Stock pursuant to Ultimate’s stock repurchase plan, and, to a lesser extent, an increase in net shares acquired to settle employee tax withholding liabilities of $0.7 million,

Days sales outstanding, calculated on a trailing three-month basis, as of September 30, 2010 and September 30, 2009, were 69 days and 67 days, respectively.

Deferred revenues were $70.4 million at September 30, 2010, as compared to $68.6 million at December 31, 2009.  The increase of $1.8 million in deferred revenues was primarily due to higher deferred SaaS revenues, partially offset by decreased deferred maintenance revenues primarily due to decreased maintenance billings and, to a lesser extent, decreased deferred services revenues.

We believe that cash and cash equivalents, investments in marketable securities, equipment financing and cash generated from operations will be sufficient to fund our 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.

 We did not have any material commitments for capital expenditures as of September 30, 2010.
 
 
Off-Balance Sheet Arrangements

We do not, and as of September 30, 2010 we did 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 our financial condition, results of operations, liquidity, capital expenditures or capital resources.

Quarterly Fluctuations

Our quarterly revenues and operating results have varied significantly in the past and are likely to vary substantially from quarter to quarter in the future. Our 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, sales and marketing and the use of third-party consultants), timing of product releases, increased competition, variations in the mix of revenues, announcements of new products by us or our competitors and capital spending patterns of our customers. We establish our expenditure levels based upon our expectations as to future revenues, and, if revenue levels are below expectations, expenses can be disproportionately high. A drop in near term demand for our 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 we will be able to maintain profitability on a quarterly basis. We believe that, due to the underlying factors for quarterly fluctuations, quarter-to-quarter comparisons of Ultimate’s 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, and Section 21E of the Securities Exchange Act of 1934, as amended. These forward-looking statements represent our expectations or beliefs, including, but not limited to, our expectations concerning our 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. Ultimate’s actual results could differ materially from those contained in the forward-looking statements due to risks and uncertainties associated with fluctuations in our quarterly operating results, concentration of our  product offerings, development risks involved with new products and technologies, competition, our contractual 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 Ultimate’s filings with the SEC.  Other factors that may cause such differences include, but are not limited to, those discussed in this Form 10-Q and the Form 10-K, including the risk factors set forth in Part I, Item 1A of the Form 10-K. Ultimate 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 Ultimate’s operations, we are exposed to certain market risks, primarily interest rate risk and foreign currency risk.  Risks that are either non-financial or non-quantifiable, such as political, economic, tax, or regulatory risks, are not included in the following assessment of our market risks.

Interest Rate Risk. Ultimate is subject to financial market risks, including changes in interest rates and in the valuations of its investment portfolio.  Changes in interest rates could impact Ultimate’s anticipated interest income from interest-bearing cash accounts, or cash equivalents and investments in marketable securities.  We manage financial market risks, including interest rate risks, in accordance with our 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.

Ultimate 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.

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, according to Ultimate’s investment guidelines, 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.

As of September 30, 2010, total investments in available-for-sale marketable securities were $9.2 million.

As of September 30, 2010, virtually all of the investments in Ultimate’s portfolio were at fixed rates (with a weighted average interest rate of 0.4% per annum).
 
To illustrate the potential impact of changes in interest rates, Ultimate has performed an analysis based on its September 30, 2010 unaudited condensed consolidated balance sheet and assuming no changes in its investments.  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 Ultimate’s total portfolio of approximately $52 thousand over the next 12 months.  An immediate and sustained 100 basis point decrease in the various base rates would result in an increase in the fair value of Ultimate’s total portfolio of approximately $52 thousand over the next 12 months.

Foreign Currency Risk.  Ultimate has foreign currency risks related to its revenue and operating expenses denominated in currencies other than the U.S. dollar.  Management does not believe movements in the foreign currencies in which Ultimate transacts b