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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF
THE SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2003
[ ] 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.
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(Exact name of Registrant as specified in its charter)
Delaware 65-0694077
- ------------------------------ ------------------------------------
State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization
2000 Ultimate Way, Weston, FL 33326
- ---------------------------------------- ----------
(Address of principal executive offices) (Zip Code)
(954) 331 - 7000
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(Registrant's telephone number, including area code)
NONE
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(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 [X] No [ ]
Indicate by check mark whether the Company is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act). Yes [ ] No [X]
As of October 31, 2003, there were 20,506,997 shares of the
Registrant's Common Stock, par value $.01, outstanding.
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THE ULTIMATE SOFTWARE GROUP, INC. AND SUBSIDIARY
TABLE OF CONTENTS
Page(s)
-------
PART I - FINANCIAL INFORMATION:
Item 1 - Financial Statements (unaudited):
Condensed Consolidated Balance Sheets as of September 30, 2003 and
December 31, 2002 3
Condensed Consolidated Statements of Operations for the Three Months
And Nine Months Ended September 30, 2003 and 2002 4
Condensed Consolidated Statements of Cash Flows for the Nine Months
Ended September 30, 2003 and 2002 5
Notes to Condensed Consolidated Financial Statements 6-10
Item 2 - Management's Discussion and Analysis of Financial Condition and Results of Operations 11-24
Item 3 - Quantitative and Qualitative Disclosures About Market Risk 24
Item 4 - Controls and Procedures 24
PART II - OTHER INFORMATION:
Item 2 - Changes in Securities and Use of Proceeds 24
Item 6 - Exhibits and Reports on Form 8-K 25
SIGNATURES 26
2
PART 1--FINANCIAL INFORMATION
ITEM 1--FINANCIAL STATEMENTS
THE ULTIMATE SOFTWARE GROUP, INC. AND SUBSIDIARY
UNAUDITED CONDENSED CONSOLIDATED BALANCE SHEETS
(Dollars in thousands, except share data)
As of As of
September 30, December 31,
2003 2002
------------- ------------
ASSETS
Current assets:
Cash and cash equivalents $ 16,054 $ 8,974
Accounts receivable, net 7,444 10,381
Prepaid expenses and other current assets 1,823 1,273
-------- --------
Total current assets 25,321 20,628
Property and equipment, net 6,709 7,233
Capitalized software, net 1,613 2,753
Other assets, net 1,368 529
-------- --------
Total assets $ 35,011 $ 31,143
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)
Current liabilities:
Accounts payable $ 1,687 $ 2,693
Accrued expenses 4,892 5,529
Current portion of deferred revenue 21,716 20,874
Current portion of capital lease obligations 761 767
Current portion of long term debt -- 501
-------- --------
Total current liabilities 29,056 30,364
Deferred revenue, net of current portion 2,009 6,941
Capital lease obligations, net of current portion 522 361
Long term debt, net of current portion -- 845
-------- --------
Total liabilities 31,587 38,511
-------- --------
Stockholders' equity (deficit):
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
in 2003 and 2002, respectively -- --
Common Stock, $.01 par value, 50,000,000 shares authorized,
20,750,122 and 16,610,790 shares issued in 2003
and 2002, respectively 208 168
Additional paid-in capital 86,446 68,602
Accumulated deficit (82,176) (75,084)
-------- --------
4,478 (6,314)
Treasury stock, 257,647 shares at cost (1,054) (1,054)
-------- --------
Total stockholders' equity (deficit) 3,424 (7,368)
-------- --------
Total liabilities and stockholders' equity (deficit) $ 35,011 $ 31,143
======== ========
3
THE ULTIMATE SOFTWARE GROUP, INC. AND SUBSIDIARY
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,
--------------------------- ---------------------------
2003 2002 2003 2002
-------- -------- -------- --------
Revenues, net:
License $ 2,506 $ 3,625 $ 5,783 $ 9,319
Recurring 7,364 4,936 21,338 12,911
Services 5,440 5,932 16,811 16,464
-------- -------- -------- --------
Total revenues, net 15,310 14,493 43,932 38,694
-------- -------- -------- --------
Cost of revenues:
License 182 343 662 867
Recurring 2,305 2,017 6,873 5,932
Services 4,041 4,230 12,533 13,083
-------- -------- -------- --------
Total cost of revenues 6,528 6,590 20,068 19,882
-------- -------- -------- --------
Operating expenses:
Sales and marketing 4,499 4,227 12,796 13,262
Research and development 4,807 4,683 13,663 13,349
General and administrative 1,480 2,101 4,389 4,796
-------- -------- -------- --------
Total operating expenses 10,786 11,011 30,848 31,407
-------- -------- -------- --------
Operating loss (2,004) (3,108) (6,984) (12,595)
Interest expense (50) (60) (178) (211)
Interest and other income 34 26 70 115
-------- -------- -------- --------
Net loss $ (2,020) $ (3,142) $ (7,092) $(12,691)
======== ======== ======== ========
Net loss per share -- basic and diluted $ (0.10) $ (0.19) $ (0.39) $ (0.79)
======== ======== ======== ========
Weighted average shares outstanding:
Basic and diluted 20,110 16,460 18,127 16,086
======== ======== ======== ========
4
THE ULTIMATE SOFTWARE GROUP, INC. AND SUBSIDIARY
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
For the Nine Months
Ended September 30,
---------------------------
2003 2002
-------- --------
Cash flows from operating activities:
Net loss $ (7,092) $(12,691)
Adjustments to reconcile net loss to net cash (used in)
provided by operating activities:
Depreciation and amortization 3,779 4,426
Provision for doubtful accounts 262 1,027
Non-cash issuance of stock options for board fees and services 93 63
Changes in operating assets and liabilities:
Accounts receivable 2,675 1,838
Prepaid expenses and other current assets (550) (270)
Other assets (546) (175)
Accounts payable (1,006) (55)
Accrued expenses (652) (780)
Deferred revenue (4,090) 8,017
-------- --------
Net cash (used in) provided by operating activities (7,127) 1,400
-------- --------
Cash flows from investing activities:
Purchases of property and equipment (1,303) (3,274)
Acquisition (350) --
-------- --------
Net cash used in investing activities (1,653) (3,274)
-------- --------
Cash flows from financing activities:
Repurchase of treasury stock -- (191)
Principal payments on capital lease obligations (585) (1,541)
Net (repayments) borrowings under Credit Facility (1,345) 927
Net proceeds from issuances of Common Stock 17,790 2,517
-------- --------
Net cash provided by financing activities 15,860 1,712
-------- --------
Net increase (decrease) in cash and cash equivalents 7,080 (162)
Cash and cash equivalents, beginning of period 8,974 8,464
-------- --------
Cash and cash equivalents, end of period $ 16,054 $ 8,302
======== ========
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid for interest $ 123 $ 171
======== ========
SUPPLEMENTAL DISCLOSURE OF NON-CASH FINANCING ACTIVITIES:
- The Company entered into capital lease obligations to acquire new
equipment totaling $740 and $1,007 in the nine months ended September 30,
2003 and 2002, respectively.
5
THE ULTIMATE SOFTWARE GROUP, INC. AND SUBSIDIARY
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
1. BASIS OF PRESENTATION
The accompanying condensed consolidated financial statements of The
Ultimate Software Group, Inc. and subsidiary (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 accounting
principles generally accepted in the United States 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 financial statements
and notes thereto included in the Company's Annual Report on Form 10-K for the
fiscal year ended December 31, 2002 filed with the SEC on March 31, 2003 (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 accounting principles
generally accepted in the United States 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, 2003 are
not necessarily indicative of operating results for the full fiscal year or for
any future periods.
STOCK-BASED COMPENSATION
The Company accounts for employee stock options in accordance with
Accounting Principles Board ("APB") No. 25, "Accounting for Stock Issued to
Employees" ("APB 25"). Under APB 25, the Company recognizes no compensation
expense related to employee stock options since options are granted at a price
equal to the market price of the underlying stock on the date of grant.
The Company's Nonqualified Stock Option Plan (the "Plan") authorizes
the grant of options to directors, officers and employees of the Company for up
to 9,000,000 shares of the Company's Common Stock. As of September 30, 2003,
3,447,456 shares of the Company's Common Stock were available for grant. Options
granted generally have a 10-year term, vesting 25% immediately and 25% for each
of the following three years.
The pro forma information below is based on provisions of Statement of
Financial Accounting Standard ("SFAS") No. 123, "Accounting for Stock-Based
Compensation ("SFAS No. 123"), as amended by SFAS No. 148, "Accounting for
Stock-Based Compensation - Transition and Disclosure" ("SFAS No. 148").
The following pro forma information regarding net loss and net loss per
share, as required by SFAS No. 123, has been determined as if the Company had
accounted for its stock-based compensation plan under the fair value method. The
fair value of each option granted was estimated at the date of grant using the
Black-Scholes option pricing model with the following weighted average
assumptions used for grants: risk-free interest rates of 3.125% for 2003 and
3.0% for 2002, a dividend yield of 0% for all periods presented, expected
volatility of 48.5% for 2003 and 68.0% for 2002 and an expected life of four
years for 2003 and three years for 2002.
6
The Company's pro forma information is as follows (in thousands, except
per share amounts):
For the Three Months For the Nine Months
Ended September 30, Ended September 30,
--------------------------- ---------------------------
2003 2002 2003 2002
--------- -------- --------- --------
Net loss:
As reported $ (2,020) $ (3,142) $ (7,092) $(12,691)
Stock-based employee compensation as determined
under fair value method for all awards (222) (440) (951) (1,427)
-------- -------- -------- --------
Pro forma $ (2,242) $ (3,582) $ (8,043) $(14,118)
======== ======== ======== ========
Net loss per share:
As reported, basic and diluted $ (0.10) $ (0.19) $ (0.39) $ (0.79)
Pro forma, basic and diluted $ (0.11) $ (0.22) $ (0.44) $ (0.88)
2. LIQUIDITY AND CAPITAL RESOURCES
The Company's cash flows from operations have historically been
insufficient to fund its operations. Shortfalls in cash flows from operations
have been funded primarily through the private and public sale of equity
securities and, to a lesser extent, equipment financing and borrowing
arrangements.
From January 1, 2003 through July 16, 2003, the Company raised an
aggregate of approximately $17.6 million of capital, net of estimated stock
issuance costs, through the private sales of (i) a total of 1,708,000 shares of
the Company's common stock, par value $0.01 per share (the "Common Stock"), and
warrants to purchase an aggregate 170,800 shares of Common Stock at $4.00 per
share to investors, including Ceridian Corporation and some existing
shareholders; and (ii) a total of 2,200,000 shares of Common Stock at $5.30 per
share, before stock issuance costs, to two institutional investors (the "Recent
Capital Raised").
On March 27, 2003, the Company amended its revolving line of credit
agreement with Silicon Valley Bank (the "Credit Facility") to extend the
expiration date of the agreement to May 28, 2004. As of September 30, 2003,
there was no amount outstanding under the Credit Facility. The Company is in the
process of negotiating the potential renewal of the Credit Facility.
For the three months ended September 30, 2003, the Company used an
average of $0.4 million per month in cash to fund its operations ("Average
Monthly Cash Flow Deficit"). Cash and cash equivalents at September 30, 2003
totaling $16.1 million would cover 12 months' future cash flow needs, based on
the Average Monthly Cash Flow Deficit. Therefore, the Company believes that cash
and cash equivalents, cash generated from operations, including Recent Capital
Raised, and available borrowings under the Credit Facility 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 operating expenses and costs of revenues, and collections of accounts
receivable.
7
3. CONCENTRATION OF REVENUES
During both the three months and nine months ended September 30, 2003,
one of the Company's customers, Ceridian Corporation ("Ceridian"), accounted for
17% of total revenues. No other customer accounted for more than 10% of total
revenues in 2003 or 2002.
Of the 17% of total revenues recognized from Ceridian for the three-
and nine-month periods ended September 30, 2003, 13% related to recurring
revenue recognized pursuant to the Original Ceridian Agreement, discussed below,
and 4% related to services revenue recognized under the Ceridian Services
Agreement, discussed below.
During 2001, the Company and Ceridian reached an agreement, as amended
in 2002, which granted Ceridian a non-exclusive license to use Ultimate
Software's UltiPro Workforce Management Software ("UltiPro") as part of an
on-line offering that Ceridian is marketing primarily to businesses with under
500 employees (the "Original Ceridian Agreement"). The aggregate minimum
payments that Ceridian is obligated to pay the Company under the Original
Ceridian Agreement over the minimum term of the agreement total $42.7 million.
To date, Ceridian has paid to the Company a total of $16.5 million under the
Original Ceridian Agreement. The earliest date upon which the Ceridian Agreement
can be terminated by either party (except for an uncured material breach) is
March 9, 2008, resulting in an expected minimum term of 7 years (the "Minimum
Term"). Ceridian retains certain rights to use the software upon termination. A
minimum of approximately $642,000 has been and is scheduled to be recognized as
subscription revenue, a component of recurring revenue, on a monthly basis, from
the Original Ceridian Agreement for the period beginning August 28, 2002 through
the end of the Minimum Term.
On February 10, 2003, the Company entered into a services agreement
(the "Ceridian Services Agreement") with Ceridian. Under the Ceridian Services
Agreement, the Company is, through the expiration date, December 31, 2003,
required to:
1) locate an employee at Ceridian's office in Atlanta, Georgia dedicated to
assist Ceridian in the resolution of any issues concerning the
development, integration and troubleshooting of the Company's UltiPro
Workforce Management Software, a Web-based solution designed to deliver
the functionality businesses need to manage the employee life cycle
("UltiPro"), as used by Ceridian;
2) provide work space at the Company's headquarters in Weston, Florida for
an employee of Ceridian for the purpose of ongoing coordination and
understanding of general and technical product requirements, integration
requirements and general communication of development status and issue
resolution;
3) allow Ceridian to provide input related to development plans (with no
approval rights granted to Ceridian and without any obligation on the
Company's part to incorporate such input into its development plans) for
UltiPro and to grant Ceridian access to the early stages of upcoming
product releases; and
4) test methodologies which could extend performance and scalability of
UltiPro in the service bureau environment and consider methodologies
which can improve performance and scalability.
Ceridian is required to pay Ultimate Software a total of $2.25 million
in four equal installments during each calendar quarter of 2003 in exchange for
the services provided by Ultimate Software. Ceridian paid Ultimate Software the
first three installments of $562,500 each during March, June and September 2003,
respectively. Services revenue from the Ceridian Services Agreement is
recognized on a straight-line basis from the date of the agreement through the
expiration of such agreement.
8
4. ACQUISITION
On June 9, 2003, the Company purchased substantially all of the assets
of Hireworks, Inc., a software company that developed, marketed and supported an
Internet recruitment solution. The assets acquired included customer contracts,
the source code for its software and computer equipment. The Company has
accounted for this transaction as a purchase. The resulting intangible asset
related to the customer contracts acquired is being amortized over 26 months.
5. COMPREHENSIVE INCOME
Statement of Financial Accounting Standards ("SFAS") No. 130,
"Reporting Comprehensive Income," establishes standards for the reporting and
display of comprehensive income and its components in a full set of 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.
Comprehensive loss is equal to net loss for all periods presented.
6. EARNINGS PER SHARE
The following is a reconciliation of the shares used in the computation
of basic and diluted net income (loss) per share (in thousands):
For the Three Months For the Nine Months
Ended September 30, Ended September 30,
---------------------- ----------------------
2003 2002 2003 2002
------ ------ ------ ------
Weighted average shares outstanding 20,110 16,460 18,127 16,086
Effect of dilutive stock options -- -- -- --
------ ------ ------ ------
Dilutive shares outstanding 20,110 16,460 18,127 16,086
====== ====== ====== ======
Options outstanding which are not included in the
calculation of diluted loss per share because
their impact is antidilutive 5,257 4,618 5,257 4,618
====== ====== ====== ======
7. RECENT ACCOUNTING LITERATURE
In January 2003, the FASB issued Interpretation No. 46, "Consolidation
of Variable Interest Entities," ("FIN 46"). FIN 46 clarifies the application of
Accounting Research Bulletin No. 51, "Consolidated Financial Statements," for
certain entities that do not have sufficient equity at risk for the entity to
finance its activities without additional subordinated financial support from
other parties or in which equity investors do not have the characteristics of a
controlling financial interest ("variable interest entities"). Variable interest
entities within the scope of FIN 46 will be required to be consolidated by their
primary beneficiary. The primary beneficiary of a variable interest entity is
determined to be the party that absorbs a majority of the entity's expected
losses, receives a majority of its expected returns, or both. FIN 46 applies
immediately to variable interest entities created after January 31, 2003, and at
the beginning of the first interim or annual period beginning after June 15,
2003, for interests acquired in variable interest entities before February 1,
2003. The FASB has delayed the effective date for variable interest entities
created before February 1, 2003 until the end of the first interim or annual
period after December 15, 2003 (which is December 31, 2003 for the Company). The
Company is in the process of determining the impact, if any, the adoption of the
provisions of FIN 46 will have upon its unaudited consolidated financial
statements. The Company had no transitional disclosures required by FIN 46.
9
In April 2003, the FASB issued SFAS No. 149 ("SFAS No. 149"),
"Amendment of Statement 133 on Derivative Instruments and Hedging Activities."
SFAS No. 149 amends and clarifies financial accounting and reporting for
derivative instruments, including certain derivative instruments embedded in
other contracts (collectively referred to as derivatives) and for hedging
activities under SFAS No. 133. SFAS No. 149 is effective for contracts entered
into or modified after September 30, 2003, and hedging relationships designated
after September 30, 2003, except for those provisions of SFAS No. 149 which
relate to SFAS No. 133 Implementation Issues that have been effective for fiscal
quarters that began prior to June 15, 2003. For those issues, the provisions
that are currently in effect should continue to be applied in accordance with
their respective effective dates. In addition, certain provisions of SFAS No.
149, which relate to forward purchases or sales of when-issued securities or
other securities that do not yet exist, should be applied to both existing
contracts and new contracts entered into after September 30, 2003. The Company
is currently assessing the financial impact of SFAS No. 149 on its unaudited
consolidated financial statements.
In May 2003, the FASB issued SFAS No. 150 ("SFAS No. 150"), "Accounting
for Certain Financial Instruments with Characteristics of both Liabilities and
Equity." SFAS No. 150 establishes standards for how an issuer classifies and
measures certain financial instruments with characteristics of both liabilities
and equity. SFAS No. 150 requires that an issuer classify a financial instrument
that is within the scope of SFAS No. 150 as a liability. SFAS No. 150 is
effective for financial instruments entered into or modified after May 31, 2003,
and otherwise is effective for the Company beginning September 1, 2003. The
adoption of SFAS No. 150 did not have an impact on the Company's unaudited
consolidated financial statements.
10
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
Form 10-Q.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
The preparation of financial statements in conformity with accounting
principles generally accepted in the United States 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.
REVENUE RECOGNITION
Sources of revenue for the Company include:
o Sales of perpetual licenses for UltiPro;
o Sales of perpetual licenses for UltiPro in conjunction with
services to host the UltiPro application (or "Hosting
Services");
o Sales of the right to use UltiPro through the Company's
Intersourcing Offering (defined below), which includes Hosting
Services;
o Sales of Hosting Services on a stand-alone basis to customers
who already own a perpetual license or are simultaneously
acquiring a perpetual license for UltiPro ("Base Hosting");
o Sales of other services including implementation, training and
other services, including the provision of payroll-related
forms and the printing of Form W-2's for certain customers, as
well as services provided to Ceridian Corporation ("Ceridian")
pursuant to the Ceridian Services Agreement (defined below);
and
o Recurring revenues derived from (1) maintenance revenues
generated from maintaining, supporting and providing periodic
updates for the Company's software and (2) subscription
revenues generated from per employee per month ("PEPM") fees
earned through the Intersourcing Offering (defined below),
Base Hosting and the business service provider (BSP) sales
channel (defined below), as well as revenues generated from
the Original Ceridian Agreement.
PERPETUAL LICENSES FOR ULTIPRO SOLD WITH OR WITHOUT HOSTING SERVICES
Sales of perpetual licenses for UltiPro and sales of perpetual licenses
for UltiPro in conjunction with Hosting Services are multiple-element
arrangements that involve the sale of software and consequently fall under the
guidance of SOP 97-2 for revenue recognition.
The Company licenses software under non-cancelable license agreements
and provides services including maintenance, training and implementation
consulting services. In accordance with the provisions of Statement of Position
("SOP") 97-2, "Software Revenue Recognition," license revenues are generally
recognized when (1) a non-cancelable license agreement has been signed by both
parties, (2) the product has been shipped, (3) no significant vendor obligations
remain and (4) collection of the related receivable is considered probable. To
the extent any one of these four criteria is not satisfied, license revenue is
deferred and not recognized in the consolidated statements of operations until
all such criteria are met.
11
For multiple-element software arrangements, each element of the
arrangement is analyzed and the Company allocates a portion of the total fee
under the arrangement to the elements based on the fair value of the element,
regardless of any separate prices stated within the contract for each element.
Fair value is generally considered the price a customer would be required to pay
if the element were to be sold separately. The Company applies the residual
method as allowed under SOP 98-9, "Modifications of SOP 97-2, Software Revenue
Recognition With Respect to Certain Transactions" in accounting for any element
of an arrangement that remains undelivered.
The residual method is used to recognize revenue when a license
agreement includes one or more elements to be delivered at a future date and
vendor specific objective evidence of the fair value of all undelivered elements
exists. The fair value of the undelivered elements is determined based on the
historical evidence of stand-alone sales of these elements to third parties.
Under the residual method, the fair value of the undelivered elements is
deferred and the remaining portion of the arrangement fee is recognized as
revenue. If evidence of the fair value of one or more undelivered elements does
not exist, the revenue is deferred and recognized when delivery of those
elements occurs or when fair value can be established.
The Company's customer contracts are non-cancelable agreements. The
Company does not provide for rights of return or price protection on its
software. The Company provides a limited warranty that its software will perform
in accordance with user manuals for varying periods, which are generally less
than one year from the contract date. The Company's customer contracts generally
do not include conditions of acceptance. However, if conditions of acceptance
are included in a contract or uncertainty exists about customer acceptance of
the software, license revenue is deferred until acceptance occurs.
SALES GENERATED FROM THE INTERSOURCING OFFERING
Subscription revenues generated from the Intersourcing Offering,
defined below, are recognized in accordance with Emerging Issues Task Force
("EITF") No. 00-21, "Revenue Arrangements with Multiple Deliverables" as a
services arrangement since the customer is purchasing the right to use UltiPro
rather than licensing the software on a perpetual basis. Fair value of multiple
elements in Intersourcing arrangements is assigned to each element based on the
guidance provided by EITF 00-21.
The elements that typically exist in Intersourcing arrangements include
hosting services, the right to use UltiPro, maintenance of UltiPro (i.e.,
product enhancements and customer support) and professional services (i.e.,
implementation services and training in the use of UltiPro). The pricing for
hosting services, the right to use UltiPro and maintenance of UltiPro is bundled
(the "Bundled Elements"). Since these three Bundled Elements are components of
recurring revenues in the consolidated statements of operations, allocation of
fair values to each of the three elements is not necessary since they are not
reported separately. Fair value for the Bundled Elements, as a whole, is based
upon evidence provided by the Company's pricing for Intersourcing arrangements
sold separately. The Bundled Elements are provided on an ongoing basis and
represent undelivered elements under EITF 00-21; they are recognized on a
monthly basis as the services are performed, once the customer has begun to
process payrolls used to pay their employees (i.e., goes "Live").
Implementation and training services (the "Professional Services")
provided for Intersourcing arrangements are priced on a time and materials basis
and are recognized as services revenue in the consolidated statements of
operations as the services are performed. Under EITF 00-21, fair value is
assigned to service elements in the arrangement based on their relative fair
values, using the prices established when the services are sold on a stand-alone
basis. If evidence of the fair value of one or more undelivered elements does
not exist, the revenue is deferred and recognized when delivery of those
elements occurs or when fair value can be established. The Company believes that
applying EITF 00-21
12
to Intersourcing arrangements as opposed to applying SOP 97-2 is appropriate
given the nature of the arrangements whereby the customer has no right to the
UltiPro license.
SALES OF BASE HOSTING SERVICES
Subscription revenues generated from Base Hosting are recognized in
accordance with EITF 00-3, "Application of AICPA Statement of Position 97-2 to
Arrangements That Include the Right to Use Software Stored on Another Entity's
Hardware," which provides guidance as to the application of SOP 97-2 to hosting
arrangements that include a license right to the software. The elements that
typically exist for Base Hosting arrangements include hosting services and
implementation services. Base Hosting is different than Intersourcing
arrangements (described above) in that the customer already owns a perpetual
license or is purchasing a perpetual license for UltiPro and is purchasing
hosting services subsequently in a separate transaction whereas, with
Intersourcing, the customer is purchasing the right to use (not license)
UltiPro. Implementation services provided for Base Hosting arrangements are
substantially less than those provided for Intersourcing arrangements since
UltiPro is already implemented in Base Hosting arrangements and only needs to be
transitioned to a hosted environment. Fair value for hosting services is based
upon evidence provided by the Company's pricing for Base Hosting arrangements
sold separately. Fair value for implementation services is assigned in
accordance with guidelines provided by SOP 97-2. In determining the application
of the appropriateness of SOP 97-2 or EITF 00-3, the Company followed the
guidance provided by EITF 00-3.
OTHER SERVICES, INCLUDING IMPLEMENTATION AND TRAINING SERVICES
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, as
well as certain reimbursable out-of-pocket expenses. Revenues for training and
implementation consulting services are recognized as services are performed.
Other services are recognized as the product is shipped or as the services are
rendered. Revenues for services provided to Ceridian pursuant to the Ceridian
Services Agreement (defined below) are recognized ratably from February 11, 2003
until December 31, 2003 based on the terms of the agreement.
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. If a sufficient basis to measure the progress towards completion
does not exist, revenue is recognized when the project is completed or when we
receive final acceptance from the customer.
RECURRING REVENUES
Recurring revenues include maintenance revenues and subscription
revenues. Maintenance revenues are derived from maintaining, supporting and
providing periodic updates for the Company's software. Subscription revenues are
principally derived from per employee per month ("PEPM") fees earned through the
Intersourcing Offering (defined below), hosting services offered to customers
that license UltiPro on a perpetual basis ("Base Hosting") and the business
service provider (BSP) sales channel (defined below), as well as revenues
generated from the Original Ceridian Agreement. Maintenance revenues are
recognized ratably over the service period, generally one year. Maintenance and
support fees are generally priced as a percentage of the initial license fee for
the underlying products. Subscription revenues are recognized ratably over the
term of the related contract upon the delivery of the product and services.
Commencing on August 28, 2002, subscription revenues generated from the Original
Ceridian Agreement are recognized ratably over the minimum term of the contract,
which is expected to extend until March 9, 2008 (7 years from the effective date
of the Original Ceridian
13
Agreement). Subscription revenues of approximately $642,000 per month are based
on guaranteed minimum payments from Ceridian Corporation of approximately $42.7
million over the contract term, including $16.5 million received to date.
Maintenance services provided to customers include product updates and
technical support services. Product updates are included in general releases to
the Company's customers and are distributed on a periodic basis. Such updates
may include, but are not limited to, product enhancements, payroll tax updates,
additional security features or bug fixes. All features provided in general
releases are unspecified upgrade rights. To the extent specified upgrade rights
or entitlements to future products are included in a multi-element arrangement,
revenue is recognized upon delivery provided fair value for the elements exists.
In multi-element arrangements that include a specified upgrade right or
entitlement to a future product, if fair value does not exist for all
undelivered elements, revenue for the entire arrangement is deferred until all
elements are delivered or when fair value can be established.
Subscription revenues generated from the BSP sales channel include both
the right to use UltiPro and maintenance. The BSP is charged a fee on a per
employee per month basis and, in several cases, is subject to a monthly minimum
amount for the term of the related agreement. Revenue is recognized on a per
employee per month basis. The Company generally does not host UltiPro for the
BSP sales channel.
The Company recognizes revenue in accordance with the SEC Staff
Accounting Bulletin No. 101, "Revenue Recognition in Financial Statements" ("SAB
No. 101"). Management believes the Company is currently in compliance with the
current provisions set forth in SOP 97-2, SOP 98-9, EITF 00-21, EITF 00-3 and
SAB No. 101.
CONCENTRATION OF REVENUES
During both the three and nine months ended September 30, 2003, one of
the Company's customers, Ceridian Corporation, accounted for 17% of total
revenues. No other customer accounted for more than 10% of total revenues in
2003 or 2002. Due to the significant concentration of total revenues with this
single customer, the Company has exposure if this customer loses its credit
worthiness. See Note 3 of the unaudited Notes to Condensed Consolidated
Financial Statements.
ALLOWANCE FOR DOUBTFUL ACCOUNTS
The Company maintains an allowance for doubtful accounts at an amount
estimated to be sufficient to provide adequate protection against losses
resulting from collecting less than full payment on accounts receivables. In
assessing the adequacy of the allowance for doubtful accounts, the Company
considers multiple factors including historical bad debt experience, the general
economic environment, and the aging of its receivables. A considerable amount of
judgment is required when the realization of receivables is assessed, including
assessing the probability of collection and current credit-worthiness of each
customer. If the financial condition of the Company's customers were to
deteriorate, resulting in an impairment of their ability to make payments, an
additional provision for doubtful accounts may be required.
SOFTWARE DEVELOPMENT COSTS
SFAS No. 86, "Accounting for the Costs of Computer Software to be Sold,
Leased or Otherwise Marketed," requires capitalization of certain software
development costs subsequent to the establishment of technological feasibility.
Based on the Company's product development process, technological feasibility is
established upon completion of a working model. There were no software costs
capitalized during 2003 or 2002. Annual amortization is based on the greater of
the amount computed using (a) the ratio that current gross revenues for the
related product bears to the total of current and anticipated future gross
revenues
14
for that product or (b) the straight-line method over the remaining estimated
economic life of the product including the period being reported on. Capitalized
software is amortized using the straight-line method over the estimated useful
lives of the assets which are typically three years. Amortization of capitalized
software was $380,000 and $458,000 for the three months ending September 30,
2003 and 2002, respectively and $1,139,000 and $1,369,000 for the nine months
ending September 30, 2003 and 2002. Accumulated amortization of capitalized
software was $3.0 million for the period ended September 30, 2003 and $2.5
million for the period ended September 30, 2002. The Company evaluates the
recoverability of capitalized software based on estimated future gross revenues
reduced by the estimated costs of completing the products and of performing
maintenance and customer support. If the Company's gross revenues were to be
significantly less than its estimates, the net realizable value of the Company's
capitalized software intended for sale would be impaired, which could result in
the write-off of all or a portion of the unamortized balance of such capitalized
software.
OVERVIEW
Ultimate Software designs, markets, implements and supports payroll and
workforce management solutions.
Ultimate Software's UltiPro Workforce Management ("UltiPro") is a
Web-based solution designed to deliver the functionality businesses need to
manage the employee life cycle, whether their processes are centralized at
headquarters or distributed across multiple divisions or branch offices.
UltiPro's human resources ("HR") and benefits management functionality is wholly
integrated with a flexible payroll engine, reporting and analytical
decision-making tools, and a central Web portal that can serve as the customer's
gateway for its workforce to access company-related and personal information.
Ultimate Software believes that UltiPro helps customers streamline HR and
payroll processes to significantly reduce administration and operational costs,
while also empowering executives and staff to access critical information
quickly and perform routine business activities efficiently.
UltiPro is marketed both through the Company's direct sales team as
well as through alliances with business service providers (BSPs) that market
co-branded UltiPro to their customer bases. Ultimate Software's direct sales
team focuses on companies with more than 500 employees and sells both on a
license (typically in-house) and service basis (typically hosted and priced on a
per-employee-per-month basis). The Company's BSP alliances focus primarily on
companies with under 500 employees and typically sell an Internet solution
priced on a monthly/service basis, sharing revenue with Ultimate Software.
The Company's direct sales force markets UltiPro as an in-house payroll
and workforce management solution and alternatively as the Intersourcing
Offering. Intersourcing provides Web access to comprehensive workforce
management functionality for organizations that need to simplify the information
technology (IT) support requirements of their business applications. Ultimate
Software believes that Intersourcing is attractive to companies that are
striving to focus on their core competencies to increase sales and profits.
INTERSOURCING OFFERING
In 2002, the Company introduced a hosting service through which the
Company provides the hardware, infrastructure, ongoing maintenance and back-up
services for its customers at a BellSouth data center (the "Intersourcing
Offering"). 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. Hosting services, typically available in a shared
environment, provide Web access to comprehensive workforce management
functionality for organizations that need to simplify the information technology
(IT) support requirements of their business applications and are priced on a
per-employee-per-month basis. In the shared
15
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 center.
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 in a shared or dedicated
hosted environment. The pricing for Intersourcing, including both the hosting
element as well as the right to use UltiPro, is on a per-employee-per-month
basis.
CERIDIAN SERVICES AGREEMENT
On February 10, 2003, Ultimate Software entered into a services
agreement (the "Ceridian Services Agreement") with Ceridian. Under the Ceridian
Services Agreement, Ultimate Software is, through December 31, 2003, required
to:
1) locate an employee at Ceridian's office in Atlanta, Georgia dedicated to
assist Ceridian in the resolution of any issues concerning the
development, integration and troubleshooting of UltiPro as used by
Ceridian;
2) provide work space at Ultimate Software's headquarters in Weston, Florida
for an employee of Ceridian for the purpose of ongoing coordination and
understanding of general and technical product requirements, integration
requirements and general communication of development status and issue
resolution;
3) allow Ceridian to provide input related to development plans (with no
approval rights granted to Ceridian and without any obligation on
Ultimate Software's part to incorporate such input into its development
plans) for UltiPro and to grant Ceridian access to the early stages of
upcoming product releases; and
4) test methodologies which could extend performance and scalability of
UltiPro in the service bureau environment and consider methodologies
which can improve performance and scalability.
Ceridian is required to pay Ultimate Software a total of $2.25 million
in four equal installments during each calendar quarter of 2003 in exchange for
the services provided by Ultimate Software. Ceridian paid Ultimate Software the
first three installments of $562,500 each during March, June and September 2003,
respectively. Services revenue is recognized on a straight-line basis from
February 10, 2003 through December 31, 2003.
ORIGINAL CERIDIAN AGREEMENT
During 2001, Ultimate Software and 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 intends to market
primarily to businesses with under 500 employees (the "Original Ceridian
Agreement"). The aggregate minimum payments that Ceridian is obligated to pay
Ultimate Software under the Original Ceridian Agreement over the minimum term of
the agreement is $42.7 million. To date, Ceridian has paid to Ultimate Software
a total of $16.5 million under the Original Ceridian Agreement. The earliest
date upon which the Ceridian Agreement can be terminated by either party (except
for an uncured material breach) is March 9, 2008, resulting in an expected
minimum term of 7 years.
COMPANY BACKGROUND
The Company is a Delaware corporation formed in April 1996 to assume
the business and operations of The Ultimate Software Group, Ltd. (the
"Partnership"), a limited partnership founded in 1990. Ultimate Software's
headquarters are located at 2000 Ultimate Way, Weston, Florida 33326 and its
16
telephone number is (954) 331-7000. To date, the Company derives no revenue from
customers outside of the United States and has no assets located outside of the
United States.
RESULTS OF OPERATIONS
The following table sets forth the Statement 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,
--------------------- ---------------------
2003 2002 2003 2002
----- ----- ----- -----
Revenues:
License 16.4% 25.0% 13.1% 24.1%
Recurring 48.1 34.1 48.6 33.4
Services 35.5 40.9 38.3 42.5
----- ----- ----- -----
Total revenues 100.0 100.0 100.0 100.0
----- ----- ----- -----
Cost of revenues:
License 1.2 2.4 1.5 2.2
Recurring 15.1 13.9 15.6 15.3
Services 26.3 29.2 28.6 33.9
----- ----- ----- -----
Total cost of revenues 42.6 45.5 45.7 51.4
----- ----- ----- -----
Operating expenses:
Sales and marketing 29.4 29.2 29.1 34.3
Research and development 31.4 32.3 31.1 34.5
General and administrative 9.7 14.5 10.0 12.4
----- ----- ----- -----
Total operating expenses 70.5 76.0 70.2 81.2
----- ----- ----- -----
Operating loss (13.1) (21.5) (15.9) (32.6)
Interest expense (0.3) (0.4) (0.4) (0.5)
Interest and other income 0.2 0.2 0.2 0.3
----- ----- ----- -----
Net loss (13.2)% (21.7)% (16.1) (32.8)%
===== ===== ===== =====
REVENUES
The Company's revenues are derived from three principal sources:
software licenses ("license revenues"), recurring revenues and services
revenues.
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 noncancellable. 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 that are included with deferred revenues in the condensed consolidated
balance sheets.
Recurring revenues include maintenance and subscription revenues.
Maintenance revenues are derived from maintaining, supporting and providing
periodic updates for the Company's software. Subscription revenues are
principally derived from per employee per month ("PEPM") fees earned through the
Intersourcing Offering, Base Hosting and the BSP sales channel, as well as
revenues generated from the Original Ceridian Agreement. Maintenance revenues
are recognized ratably over the service period, generally one year. Subscription
revenues are recognized ratably over the term of the related contract upon the
delivery of the product and services. All of the Company's customers that
purchased software during 2003 and 2002 also purchased maintenance and support
service contracts. Maintenance and support fees are generally priced as a
percentage of the initial license fee for the underlying products.
17
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, as
well as revenue generated from the Ceridian Services Agreement and certain
reimbursable out-of-pocket expenses. Revenues for training and implementation
consulting services are recognized as services are performed. Revenues for the
Ceridian Services Agreement are recognized ratably from February 11, 2003 until
December 31, 2003 based on the terms of the agreement. Other services are
recognized as the product is shipped or as the services are rendered.
Total revenues, consisting of license, recurring and services revenues,
increased 5.6% to $15.3 million for the three months ended September 30, 2003
from $14.5 million for the three months ended September 30, 2002. Total revenues
increased 13.5 % to $43.9 million for the nine months ended September 30, 2003
from $38.7 million for the nine months ended September 30, 2002.
License revenues decreased 30.9% to $2.5 million for the three months
ended September 30, 2003 from $3.6 million for the three months ended September
30, 2002. License revenues decreased 37.9% to $5.8 million for the nine months
ended September 30, 2003 from $9.3 million for the nine months ended September
30, 2002. The decreases in license revenues were due to the combination of fewer
licensed units sold, principally due to a shift in targeted sales, and a
decrease in sales of UltiPro to existing clients using the Company's DOS-based
product, UltiPro for Lan ("DOS Clients"). In the second half of 2002, the
Company adjusted its sales and marketing strategy to include sales from its
Intersourcing Offering, which produces subscription revenues (a component of
recurring revenues) rather than license revenues. For the nine-month period
ended September 30, 2003, more units were sold from the Intersourcing Offering
than in the prior year. In addition, sales of the UltiPro product to DOS Clients
ended during the last fiscal quarter of 2002, shortly before support for UltiPro
for Lan was discontinued (in January 2003). Prior to discontinuing support, the
Company actively marketed the UltiPro product to DOS Clients as part of a
loyalty program designed to encourage these clients to purchase UltiPro before
support for UltiPro for Lan was discontinued. More than half of the DOS Clients
converted to the UltiPro product in 2002.
Recurring revenues increased 49.2% to $7.4 million for the three months
ended September 30, 2003 from $5.0 million for the three months ended September
30, 2002. Recurring revenues increased 65.3% to $21.3 million for the nine
months ended September 30, 2003 from $12.9 million for the nine months ended
September 30, 2002. The increases in both the three- and nine-month periods were
primarily due to (i) the recognition of subscription revenues, beginning on
August 28, 2002, under the Original Ceridian Agreement, which was $1.9 million
and $5.8 million, for the three- and nine-month periods ended September 30,
2003, respectively, as compared to $0.7 million for the three- and nine-month
periods ended September 30, 2002; (ii) an increase in maintenance revenues
generated from incremental licenses sold; and, to a lesser extent, (iii)
revenues recognized pursuant to the Intersourcing Offering, which was introduced
in mid-2002. The impact on recurring revenues for units sold under the
Intersourcing Offering (as opposed to the impact on license revenues for
licensed units sold) is expected to be gradual, based on the revenue recognition
of the Intersourcing fees over the terms of the related contracts. The Company
believes that a combination of units sold under the Intersourcing Offering and
regular licensed units sold will provide a more predictable business model in
the future.
Services revenues decreased 8.3% to $5.4 million for the three months
ended September 30, 2003 from $5.9 million for the three months ended September
30, 2002. Services revenues increased 2.1% to $16.8 million for the nine months
ended September 30, 2003 from $16.5 million for the nine months ended September
30, 2002. The decrease in the three-month period ended September 30, 2003 was
primarily due to a decrease in implementation services of $1.0 million,
partially offset by an increase from revenue recognized under the Ceridian
Services Agreement beginning February 10, 2003, which contributed $0.6 million
for the quarter ended September 30, 2003. Implementation revenues decreased $0.8
million during the three months ended September 30, 2003 compared to the same
period in 2002 due
18
to fewer billable hours resulting from lower utilization of service consultants
in response to the reduction in total units sold compared to the prior year
comparable period and decreased $0.2 million due to a reduced average rate per
hour charged for their services. The increase in services revenue for the
nine-month period ended September 30, 2003 was primarily due to an increase from
revenue recognized under the Ceridian Services Agreement, which contributed $1.6
million for the period, and an increase in other services of $0.3 million,
partially offset by a decrease in implementation services of $1.6 million.
Implementation revenues decreased $1.2 million during the nine months ended
September 30, 2003 from the nine months ended September 30, 2002 due to fewer
billable hours resulting from lower utilization of service consultants in
response to the reduction in total units sold compared to the prior year
comparable period and declined $0.4 million due to a reduced average rate per
hour charged for their services.
COST OF REVENUES
Cost of revenues consists of the cost of license, recurring and
services revenues. Cost of license revenues primarily consists of fees payable
to a third party for software products distributed by the Company and, to a
lesser degree, amortization of capitalized software costs. UltiPro includes
third-party software for enhanced report writing purposes. When UltiPro licenses
are sold, customers pay the Company on a per user basis for the license rights
to the third-party report writing software. Capitalized software is amortized
using the straight-line method over the estimated useful life of the related
asset, which is typically three years. Cost of recurring revenues consists of
costs to provide maintenance and technical support to the Company's customers,
the cost of periodic updates and the costs of subscription revenues, including
amortization of capitalized software. Cost of service revenues primarily
consists of costs to provide implementation services and training to the
Company's customers and, to a lesser degree, costs associated with revenues
generated from the hosted models, including Intersourcing, costs related to
sales of payroll-related forms and costs associated with reimbursable
out-of-pocket expenses.
Total costs of revenues, consisting of license, recurring and services
revenues, of $6.5 million for the three months ended September 30, 2003 and
$20.1 million for the nine months ended September 30, 2003 were substantially
consistent with the costs of revenues for the comparable periods of the prior
year.
Cost of license revenues decreased 46.9% to $182,000 for the three
months ended September 30, 2003 from $343,000 for the three months ended
September 30, 2002. Cost of license revenues decreased 23.6% to $662,000 for the
nine months ended September 30, 2003 from $867,000 for the nine months ended
September 30, 2002. The decreases in cost of license revenues for the three- and
nine-month periods were due to lower third-party royalty fees resulting from
fewer licensed units sold and, to a lesser extent, a reduction in the
amortization of capitalized software. Cost of license revenues, as a percentage
of license revenues, decreased to 7.3% for the three months ended September 30,
2003 as compared to 9.5% for the three months ended September 30, 2002 and
increased to 11.4% for the nine months ended September 30, 2003 from 9.3% for
the nine-month period ended September 30, 2002. The decrease for the three-month
period included a rate reduction from the third-party provider during the
quarter ended September 30, 2003. The increase for the nine-month period was due
to lower license revenues on a year-to-date basis combined with certain fixed
costs of license revenues, while the rate reduction from the third-party
provider only benefited the most recent quarter. Cost of license revenues, as a
percentage of license revenues, generally fluctuates from period to period
principally due to the mix of sales of software products which generate third
party license fees in each period and fluctuations in revenues contrasted with
fixed expenses such as the amortization of capitalized software.
Cost of recurring revenues increased 14.3% to $2.3 million for the
three months ended September 30, 2003 from $2.0 million for the three months
ended September 30, 2002. Cost of recurring revenues increased 15.9% to $6.9
million for the nine months ended September 30, 2003 from $5.9 million for the
nine months ended September 30, 2002. The increases in cost of recurring revenue
for the three- and nine-month periods were primarily attributable to costs
associated with the Intersourcing
19
Offering totaling $0.2 million and $0.7 million, respectively, including
depreciation and amortization of related computer equipment and costs associated
with the Bell South data center, and higher costs of maintenance revenues
principally due to increased labor costs, including benefits. Cost of recurring
revenues, as a percentage of recurring revenues, decreased to 31.3% for the
three months ended September 30, 2003 as compared to 40.9% for the three months
ended September 30, 2002 and decreased to 32.2% for the nine months ended
September 30, 2003 from 45.9 % for the nine-month period ended September 30,
2002. The decreases in cost of recurring revenues, as a percentage of recurring
revenue, for the three and nine months ended September 30, 2003 were primarily
due to the expansion of the recurring revenue base in 2003.
Cost of services revenues decreased 4.5% to $4.0 million for the three
months ended September 30, 2003 from $4.2 million for the three months ended
September 30, 2002. Cost of services revenues decreased 4.2% to $12.5 million
for the nine months ended September 30, 2003 from $13.1 million for the nine
months ended September 30, 2002. The decrease in the three-month period ended
September 30, 2003 was due to a decrease of $0.1 million in costs of
implementation, principally due to the reduction of third-party consultant fees
and a $0.1 million decrease in client reimbursed expenses. The decrease in the
nine-month period ended September 30, 2003 was due to a decrease of $0.5 million
in costs of implementation, principally from lower third-party consultant fees.
Cost of services revenues, as a percentage of services revenues, for the three
months ended September 30, 2003 increased to 74.3% from 71.3% for the three
months ended September 30, 2002 and decreased to 74.6% for the nine months ended
September 30, 2003 from 79.5% from September 30, 2002. The increase in the cost
of services, as a percentage of services revenues, for the three-month period
was primarily due to the reduction in implementation revenues without a
corresponding decrease to the costs of implementation, partially offset by the
services revenue recognized from the Ceridian Services Agreement, which does not
have any associated costs. The decrease in the cost of services revenues, as a
percentage of services revenue, for the nine-month period was primarily due to
the services revenue recognized from the Ceridian Services Agreement, which does
not have any associated costs, partially offset by a decrease in implementation
revenues without a corresponding decrease in related implementation costs.
SALES AND MARKETING
Sales and marketing expenses consist primarily of salaries, 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 6.4% to $4.5 million for the three months
ended September 30, 2003 from $4.2 million for the three months ended September
30, 2002. Sales and marketing costs decreased 3.5% to $12.8 million for the nine
months ended September 30, 2003 from $13.3 million for the nine months ended
September 30, 2002. The primary factor contributing to the increase for the
three-month period was additional advertising and marketing costs of $0.2
million. The decrease for the nine-month period was primarily due to a decrease
in labor costs of $0.7 million, partially offset by an increase in advertising
and marketing costs of $0.3 million.
RESEARCH AND DEVELOPMENT
Research and development expenses consist primarily of software
development personnel costs. Research and development expenses increased 2.6% to
$4.8 million for the three months ended September 30, 2003 from $4.7 million for
the three months ended September 30, 2002. Research and development expenses
increased 2.4% to $13.7 million for the nine months ended September 30, 2003
from $13.3 million for the nine months ended September 30, 2002. The increases
in the three- and nine-month periods were primarily due to increases in labor
costs of $0.2 million and $0.5 million, respectively, principally resulting from
increased benefit costs and additional labor costs incurred as a result of the
June 2003 acquisition of substantially all of the assets of Hireworks, Inc., a
software company that developed, marketed and supported an Internet recruitment
solution (the "Hireworks Acquisition").
20
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 decreased 29.6% to $1.5 million for the three months
ended September 30, 2003 from $2.1 million for the three months ended September
30, 2002. General and administrative expenses decreased 8.5% to $4.4 million for
the nine months ended September 30, 2003 from $4.8 million for the nine months
ended September 30, 2002. The decrease in general and administrative expenses
for the three-month period was primarily due to a $0.5 million reduction in the
provision for doubtful accounts and a $0.3 million decrease in external
professional fees, partially offset by a $0.1 million increase in legal
settlements. The decrease in general and administrative expenses for the
nine-month period was primarily due to a $0.8 million reduction in the provision
for doubtful accounts and a $0.1 million decrease in external professional fees,
partially offset by a $0.2 million increase in legal settlements and additional
labor costs, including higher benefit costs, of $0.2 million.
INTEREST EXPENSE
Interest expense for the three and nine months ended September 30, 2003
was comparable to the expenses for the same period of 2002.
INTEREST AND OTHER INCOME
Interest and other income increased 30.8% to $34,000 for the three
months ended September 30, 2003 from $26,000 for the three months ended
September 30, 2002. Interest and other income decreased 39.1% to $70,000 for the
nine months ended September 30, 2003 from $115,000 for the nine months ended
September 30, 2002. The increase for the three-month period was due to
additional funds available for investment resulting from the private placement
completed on July 16, 2003, as discussed below. The decrease for the nine-month
period was primarily due to the reduction of funds available for investment in
2003, as the additional funds from the July 16, 2003 private placement were
available for investment for about 28% of the nine-month period.
INCOME TAXES
No provision or benefit for federal, state or foreign income taxes was
made for the three months or nine months ended September 30, 2003 or 2002 due to
the operating losses and operating loss carryforwards from prior periods
incurred in the respective periods. Net operating loss carryforwards available
at December 31, 2002, which expire at various times through the year 2022 are
available to offset future taxable income. 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's cash flows from operations have historically been
insufficient to fund its operations. Shortfalls in cash flows from operations
have been funded primarily through the private and public sale of equity
securities and, to a lesser extent, equipment financing and borrowing
arrangements.
As of September 30, 2003, the Company had $16.1 million in cash and
cash equivalents, reflecting a net increase of $7.1 million since December 31,
2002. The working capital deficit was $3.7 million as of September 30, 2003 and
$9.7 million as of December 31, 2002. The increase in working capital resulted
primarily from the additional equity raised through September 30, 2003,
partially offset
21
by the funding of operations and the voluntary payment of the full balance of
the Credit Facility, as discussed below.
Net cash used in operating activities was $7.1 million for the nine
months ended September 30, 2003 as compared to net cash provided by operating
activities of $1.4 million for the nine months ended September 30, 2002. The
increase in net cash used in operating activities was due to the funding of
operations and the reduction in cash received from Ceridian during 2003. During
the nine months ended September 30, 2003, the Company received $4.3 million less
in cash from Ceridian in comparison to the prior year. In February 2002, the
Company received $6.0 million from Ceridian as a prepayment by Ceridian of
minimum guaranteed payments for 2003 due to the Company pursuant to the Original
Ceridian Agreement, as amended from time to time. During the nine months ended
September 30, 2003, the Company did not receive any money from Ceridian under
the Original Ceridian Agreement. Payments from Ceridian under the Original
Ceridian Agreement are scheduled to resume effective January 1, 2004. During the
nine months ended September 30, 2003, the Company received $1.7 million from
Ceridian pursuant to the Ceridian Services Agreement.
Net cash used in investing activities was $1.7 million for the nine
months ended September 30, 2003 as compared to $3.3 million for the nine months
ended September 30, 2002. The decrease in net cash used in investing activities
was primarily due a reduction in purchases of property and equipment, partially
offset by the Hireworks Acquisition which totaled $350,000.
Net cash provided by financing activities for the nine months ended
September 30, 2003 was $15.9 million as compared to $1.7 million for the nine
months ended September 30, 2002. The increase in net cash provided by financing
activities was primarily due to the proceeds from the issuances of Common Stock
and warrants pursuant to several private placements from January through July
2003 and the decrease in principal payments on capital lease obligations as the
Company's equipment financing under that financing method have diminished,
partially offset by net payments (as opposed to borrowings in the prior year
comparable period) under the Credit Facility, defined below.
Days sales outstanding, calculated on a trailing three-month basis
("DSO"), as of September 30, 2003 and 2002, were 45 days and 71 days,
respectively. The decrease in DSO's in 2003 was the result of (1) the
recognition of additional subscription revenue in the three months ended
September 30, 2003 (i.e., increase of $1.2 million from the same period of 2002)
from the Original Ceridian Agreement which does not have related accounts
receivable; (2) an improvement in the quality of accounts receivable; and (3)
the Company's change in business strategy to focus on both license sales (as in
the past) and Intersourcing sales (beginning in 2002 and strengthening in 2003).
On July 16, 2003, the Company sold 2,200,000 newly issued shares of its
common stock, $0.01 par value ("Common Stock"), to two institutional investors
in a private placement for gross proceeds of approximately $11.7 million (the
"Recent Capital Raised"). These shares of Common Stock were sold at $5.30 per
share. After deducting commissions and other estimated stock issuance costs, the
Company received approximately $10.8 million. The Company has used a portion of
the proceeds from the Recent Capital Raised for general corporate purposes,
including working capital. The shares of Common Stock issued from the Recent
Capital Raised were not registered under the Securities Act of 1933 and such
shares may not be subsequently offered or sold by the investors in the United
States absent registration or an applicable exemption from the registration
requirements. Ultimate Software agreed to file a registration statement covering
resales of the Common Stock by investors, which registration statement on Form
S-3 was filed with the SEC on July 31, 2003 and amended on October 16, 2003 (the
"Form S-3"). Certain other shareholders exercised their right to include shares
owned by them in such registration statement on Form S-3. The Form S-3 is being
reviewed by the SEC as of the date of the filing of this Form 10-Q. Such SEC
review could result in the Company revising certain disclosures contained in
this Form 10-Q.
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The Company has a revolving line of credit (the "Credit Facility") with
Silicon Valley Bank, which is secured by all of the Company's assets, including
a negative pledge on intellectual property, and bears interest at a rate equal
to Prime Rate plus 1.0% per annum (reduced to Prime Rate plus 0.5% per annum
upon two consecutive quarters of net profitability). The Credit Facility
provides working capital financing for up to 75% of the Company's eligible
accounts receivable, as defined, financing for eligible equipment purchases for
up to $2.5 million with additional limits for software purchases, and stand-by
letters of credit for up to $0.5 million. The maximum amount available under the
Credit Facility is $5.0 million. The Credit Facility, as amended, expires on May
28, 2004. The Company is currently in the process of negotiating the potential
renewal of the Credit Facility. As of September 30, 2003, there was no amount
outstanding under the Credit Facility as the Company voluntarily paid-off the
balance of the Credit Facility during September 2003. Under the terms of the
Credit Facility, no dividends may be paid on the Company's Common Stock without
the consent of Silicon Valley Bank.
For the three months ended September 30, 2003, the Company used an
average of $0.4 million per month in cash to fund its operations ("Average
Monthly Cash Flow Deficit"). Cash and cash equivalents at September 30, 2003
totaling $16.1 million would cover 12 months' future cash flow needs, based on
the Average Monthly Cash Flow Deficit. Therefore, the Company believes that cash
and cash equivalents, cash generated from operations, including Recent Capital
Raised, and available borrowings under the Credit Facility 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 operating expenses and costs of revenues, and collections of accounts
receivable.
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 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 establish or, when
established, 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 contains 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 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. Factors that may cause such differences include, but are not limited
to, those discussed in the foregoing Management's Discussion and Analysis of
Financial Condition and Results of
23
Operations as well as those discussed in the Company's Annual Report on Form
10-K for the fiscal year ended December 31, 2002, filed with the SEC on March
31, 2003, including Exhibit 99.1 thereto. 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.
INTEREST RATES. Cash equivalents consist of money market accounts with
original maturities of less than three months. Interest on the Credit Facility,
as amended, which expires on May 28, 2004, is based on Prime Rate plus 1.0% per
annum. As of September 30, 2003, there was no amount outstanding under the
Credit Facility. Changes in interest rates could impact the Company's
anticipated interest income from interest-bearing cash accounts, or cash
equivalents, as well as interest expense on current and future borrowings under
the Credit Facility.
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 Chief Executive Officer (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 Securities Exchange Act of 1934
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 in timely alerting them to material information required to be
included in the Company's periodic SEC reports. 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. There have
been no significant changes in internal control over financial reporting that
have materially affected, or are reasonably likely to materially affect, the
Company's internal control over financial reporting subsequent to the date of
such evaluation.
PART II--OTHER INFORMATION
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
(c) UNREGISTERED SHARES SOLD BY THE COMPANY. On July 15, 2003, the
Company sold 2,200,000 newly issued shares of its common stock to two
institutional investors in a private placement pursuant to Section 4(2) of the
Securities Act of 1933, as amended (the "Securities Act"), for gross proceeds of
approximately $11.7 million. The shares were sold at $5.30 per share. After
deducting commissions and expenses, the Company received approximately $10.8
million.
The Company did not offer or sell the shares by any form of general
solicitation or general advertising. An underwriter was not used. The Company
received representations from each of the investors in connection with the sale
of securities, including that (i) such investor is an "accredited investor" as
defined in Rule 501(a) under the Securities Act, (ii) such investor has the
appropriate business or financial experience, (iii) such investor is able to
bear the economic risk of such investment
24
and (iv) such investor is purchasing the securities for its own account for
investment purposes only and not with a view to or for distributing or reselling
such shares.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
Number Description
------ -----------
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
32.2 Certification Pursuant to 18 U.S.C. Section 1350, as Adopted
Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
(b) Reports on Form 8-K
The Company furnished the information set forth in its press release
issued on July 23, 2003 concerning its second quarter 2003 financial results in
a Form 8-K filed with the SEC on July 24, 2003. The Company subsequently amended
and restated such filing in a Form 8-K/A filed with the SEC on July 25, 2003.
The Company reported the sale of 2,200,000 shares of its Common Stock
to two institutional investors in a Form 8-K filed with the SEC on July 16,
2003.
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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 13, 2003 By: /s/ MITCHELL K. DAUERMAN
-------------------------------------
Executive Vice President,
Chief Financial Officer and Treasurer
(Authorized Signatory and Principal
Financial and Accounting Officer)
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