UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-K

The Ultimate Software Group, Inc.

(Exact name of Registrant as specified in its charter)

Registrant’s telephone number, including area code:

(954) 331-7000

Securities registered pursuant to Section 12(b) of the Act:

None

Securities registered pursuant to Section 12(g) of the Act:

Title of Class:

Common Stock, par value $.01 per share

      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 o

      Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of Registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. o

      Indicate by check mark whether the Registrant is an accelerated filer (as defined in Exchange Act Rule 12b-2). Yes þ No o

      The aggregate market value of Common Stock, par value $.01 per share, held by non-affiliates of the Registrant, based upon the closing sale price of such shares on the Nasdaq National Market on June 30, 2004 was approximately $185.8 million.

      As of February 18, 2005, there were 22,558,866 shares of the Registrant’s Common Stock, par value $.01, outstanding.

DOCUMENTS INCORPORATED BY REFERENCE

      Portions of the Registrant’s Proxy Statement for the 2005 Annual Meeting of Stockholders are incorporated by reference into Part III of this Annual Report on Form 10-K.

THE ULTIMATE SOFTWARE GROUP, INC.

INDEX

PART I

      This Annual Report on Form 10-K (the “Form 10-K”) of The Ultimate Software Group, Inc. (“Ultimate Software” or the “Company”) may 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 the Company’s expectations or beliefs, including, but not limited to, statements concerning the Company’s operations and financial performance and condition. Words such as “anticipates,” “expects,” “intends,” “plans,” “believes,” “seeks,” “estimates,” and similar expressions are intended to identify such forward-looking statements. These forward-looking statements are not guarantees of future performance and are subject to certain risks and uncertainties that are difficult to predict. The Company’s actual results could differ materially from those contained in the forward-looking statements due to risks and uncertainties associated with fluctuations in the Company’s quarterly operating results, concentration of the Company’s product offerings, development risks involved with new products and technologies, competition, the Company’s 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 the Company’s filings with the Securities and Exchange Commission. Other factors that may cause such differences include, but are not limited to, those discussed in this Form 10-K, including Exhibit 99.1 hereto. 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.

      UltiPro® and Intersourcing® and their related designs are registered trademarks of Ultimate Software in the United States. This Form 10-K also includes names, trademarks, service marks and registered trademarks and service marks of companies other than Ultimate Software.

Item 1. Business

Overview

      Ultimate Software designs, markets, implements and supports payroll and workforce management solutions in the United States.

      Ultimate Software’s UltiPro Workforce Management Software (“UltiPro”) is a Web-based solution designed to deliver the functionality businesses need to manage the employee life cycle, from recruiting and hiring to compensating and managing benefits to terminating, whether 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 self-service Web portal for executives, managers, administrators, and employees to review and update work-related and personal information. Ultimate Software believes that UltiPro helps customers streamline HR and payroll processes to significantly reduce administrative and operational costs, while also empowering managers and staff to analyze workforce trends for better decision making, access critical information quickly and perform routine business activities efficiently.

      UltiPro Workforce Management 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 primarily on companies with more than 500 employees and sells UltiPro both as a license model (typically in-house) and a service model (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, which includes UltiPro, priced on a monthly/service basis. In 2004, Ultimate Software extended its BSP program to allow for alliances that target very large corporations, generally those having more than 10,000 employees that the Company’s direct sales force would not see in a typical sales process. When the BSP sells its Internet solution, incorporating UltiPro in the offering, the BSP is obligated to remit a fee to the Company, typically measured on a per-employee-per-month basis and, in some cases, subject to a guaranteed monthly minimum amount.

      UltiPro leverages the Microsoft technology platform, which is recognized in the industry as a cost-effective, reliable and scalable platform. As part of its comprehensive payroll and workforce management

solutions, Ultimate Software provides implementation and training services to its customers as well as support services, which have been certified by the Support Center Practices Certification program for six consecutive annual evaluations.

      The Company’s direct sales force markets UltiPro as an in-house human resources, payroll and workforce management solution and alternatively as a hosted offering branded “Intersourcing” (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 want to focus on their core competencies to increase sales and profits. Through the Intersourcing model introduced in 2002, the Company provides the hardware, infrastructure, ongoing maintenance and backup services for its customers at a BellSouth data center managed by International Business Machines (“IBM”).

      During 2001, Ultimate Software and Ceridian Corporation (“Ceridian”) reached an agreement, as amended in 2002, which granted Ceridian a non-exclusive license to use UltiPro software as part of an on-line offering that Ceridian markets primarily to businesses with less than 500 employees (the “Original Ceridian Agreement”). Ceridian marketed this offering as the SourceWeb solution, which uses UltiPro software as its core payroll and human resource platform. According to the financial terms of the Original Ceridian Agreement (the “Ceridian Financial Terms”), Ceridian is required (i) to pay the Company a monthly license fee based on the number of employees paid using the licensed software, subject to a minimum monthly payment of $500,000 per month with increases of 5% per annum, compounded beginning in January 2006. The aggregate minimum payments that Ceridian is obligated to pay Ultimate Software under the Original Ceridian Agreement over the minimum term of the agreement are $42.7 million. To date, Ceridian has paid to Ultimate Software a total of $23.0 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. Ceridian retains certain rights to use the software upon termination.

      During December 2004, RSM McGladrey Employer Services (“RSM”), an existing business service provider of Ultimate Software’s, acquired Ceridian’s SourceWeb HR/payroll and self-service product and existing SourceWeb base of small and midsize business customers throughout the United States (the “RSM Acquisition”). The Ceridian Financial Terms have not changed as a result of the RSM Acquisition. Ultimate Software expects to continue to recognize a minimum of $642,000 per month in recurring revenues from the Original Ceridian Agreement until its termination.

      Ultimate Software 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 is located at 2000 Ultimate Way, Weston, Florida 33326 and its telephone number is (954) 331-7000. To date, the Company has derived no revenue from customers outside of the United States and has no assets located outside of the United States.

Revenue Sources

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

      Recurring revenues consist of maintenance revenues, Intersourcing revenues and subscription revenues from per-employee-per-month (“PEPM”) fees generated by business partners. Maintenance revenues are derived from maintaining, supporting and providing periodic updates for the Company’s products under software license agreements. Subscription revenues are principally derived from PEPM fees earned through the Intersourcing Offering, Base Hosting (defined below) 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. To the extent there are upfront fees associated with the Intersourcing Offering, Base Hosting or the BSP sales channel, subscription revenues are recognized ratably over the term of the related contract upon the delivery of the product and services. PEPM fees from the Intersourcing Offering,

Base Hosting and the BSP sales channel are recognized as subscription revenue (a component of recurring revenues in the consolidated statements of operations) as the services are delivered.

      Services revenues include revenues from fees charged for the implementation of the Company’s software products and training of customers in the use of such products, fees for services provided to business service providers, including those related to the Ceridian Services Agreement (defined below) which expired on December 31, 2004, the provision of payroll-related forms and the printing of Form W-2’s for certain customers and certain reimbursable out-of-pocket expenses. Revenues for training and implementation consulting services are typically recognized as services are performed. Revenues for the Ceridian Services Agreement were recognized ratably from February 11, 2003 until December 31, 2004 based on the terms of the agreement. Other services are recognized as the services are rendered or as the product is shipped.

      License revenues include revenues from software license agreements for the Company’s products, entered into between the Company and its customers in which the license fees are non-cancellable. License revenues are generally recognized upon the delivery of the related software product when all significant contractual obligations have been satisfied. Until such delivery, the Company records amounts received when contracts are signed as customer deposits which are included with deferred revenues in the consolidated balance sheets.

      The percentage contribution for each of the three principal sources of revenue was as follows:

Features of UltiPro

      Ultimate Software’s UltiPro is a payroll and workforce management solution designed to offer the following features to its customers:

      Web Workforce Portal. UltiPro includes a Web workforce portal that can serve as a company’s communications hub and the central gateway for business activities. It provides functionality for everyone in the customer’s organization, not just human resources/payroll and finance departments, but also executives, staff managers and individual employees. With UltiPro’s workforce portal, a company’s HR/payroll staff, managers and administrators can complete daily employee administration tasks, administer benefits, manage staff and access reporting in real-time, from one central location. Managers and executives can perform real-time Web queries on their workforce data, access commonly requested reports and analyze workforce statistics and trends on-demand. Employees can review their own pay and benefits information, get questions answered and complete routine updates instantly. HR and other administrators can expedite more than 100 routine business processes such as hiring, rehiring or terminating an employee; inputting salary increases; and changing an employee’s job, division, or department. Ultimate Software believes that UltiPro’s workforce portal can increase administrative efficiencies by providing reporting, staff management processes and business intelligence to management over the Internet and can reduce operating costs by eliminating the need for organizations to print and distribute paper communications, handbooks, forms and paychecks.

      Feature-Rich, Built-in Functionality. UltiPro includes human resources, payroll, and benefits management, comprehensive reporting (more than 400 standard and customizable reports delivered, including government compliance reporting and strategic analytics), a workforce portal with Web-based employee and manager self-service, Web-based benefits enrollment, Web employee administration (including workflow), recruitment and training management. Based upon the amount of built-in and integrated functionality, the Company believes that UltiPro minimizes the need for extensive customizations or changes to source code,

facilitates streamlined management of the total employment cycle, and enables organizations to minimize the time invested in burdensome HR/payroll administrative activities.

      Implementation and System Update Efficiency. Ultimate Software offers a solution that has been designed to minimize the time and effort required for implementation, customization and updating. UltiPro delivers an extensive amount of functionality “out-of-the-box” so that minimal customizations are required by the customer. The Company also provides an implementation methodology, experienced implementation staff and customer training to facilitate rapid implementation. Ultimate Software continues to refine and improve its implementation process to allow customers to implement more quickly. To facilitate customizations and fast system upgrades, the Company has designed UltiPro so that when users load system updates, they do not overwrite their customizations because the system stores custom changes as sub-classed objects or data that reside “outside” the core program, thus avoiding the time-consuming process of rewriting custom changes.

      Reduced Total Cost of Ownership. The Company believes that the UltiPro solution provides cost saving opportunities for its customers and that UltiPro, whether purchased as a license or as a service through Intersourcing, is competitively priced. In addition, the Company believes that its current practices in implementing the UltiPro solution result in a cost savings for customers when compared with implementations of other similar solutions in the industry. A customer may also reduce the administrative and information technology support costs associated with the organization’s human resources, benefits and payroll functions over time. Tight integration helps to reduce administrative costs by facilitating accurate information processing and reporting, and reducing discrepancies, errors and the need for time-consuming adjustments. In addition, administrative costs can be reduced by providing an organization with greater access to information and control over reporting.

      Leveraging of Leading Technologies. Ultimate Software has consistently focused on identifying leading technologies and integrating them into its products. UltiPro Workforce Management is a three-tier solution that leverages Microsoft’s technical architecture as well as XML to increase design efficiencies within the system and particularly for workflow capabilities. With UltiPro version 6.0, released in 2002, Ultimate Software introduced new technology architecture for UltiPro to enable advanced Web Services capabilities. Ultimate Software’s Distributed Process Management platform leverages leading technologies such as Microsoft’s Component Object Model (COM), Microsoft Message Queuing (MSMQ), eXtensible Markup Language (XML), Simple Object Access Protocol (SOAP) and Web Services Definition Language (WSDL) to create a distributed processing framework that is Internet-enabled. This allows customers to initiate commonly requested services such as running a report from the Web. These requests are automatically routed to a separate process application server to ensure efficient processing and load balancing. UltiPro’s XML Web Services feature set allows customers to scale as they grow and take advantage of additional Web Services as needed. With UltiPro version 7.0, released in 2003, Ultimate Software enhanced and validated the performance of UltiPro’s Internet functions, including eEmployee Self-Service, eManagement, and eAdministration by benchmark testing with Mercury Loadrunner Controller. In addition, UltiPro includes a suite of enterprise integration tools, business components and business-to-business links. These tools are designed to take advantage of emerging Internet-based technology standards such as XML, HTTP and Java scripting.

      Ease of Use and Navigation. Ultimate Software designs its products to be user-friendly and to simplify the complexities of managing employees and complying with government regulations in the payroll and workforce management areas. UltiPro uses familiar Internet interface techniques and functions through a Web browser, which the Company believes makes it convenient and easy to use. A customer’s executives, managers, administrators and employees have Web access to manage payroll and employee functions, run reports or find answers to routine questions through an intuitive user interface. The Company refers to this easy navigation as “Two clicks to anywhere.”

      Comprehensive Professional Services and Industry-Specific Expertise. Ultimate Software believes it provides high quality implementation, training and ongoing product and customer support services. Ultimate Software employs approximately 170 people in customer services, which includes the implementation, product support, technical support and training departments. Ultimate Software’s customer support center has received the Support Center Practices (“SCP”) Certification for the sixth consecutive year. The SCP

program was created by the Service & Support Professionals Association (SSPA) and a consortium of information technology companies to create a recognized quality certification for support centers. SCP Certification quantifies the effectiveness of customer support based upon relevant performance standards and represents best practices within the technology support industry according to SSPA. Recognizing the importance of issuing timely updates that reflect changes in tax and other regulatory laws, Ultimate Software employs a dedicated research team to track jurisdictional tax changes to the more than 12,000 tax codes included in UltiPro as well as changes in other employee-related regulations.

Technology

      Ultimate Software seeks to provide its clients with optimum performance, advanced functionality and ease of scalability and access to information through the use of leading Internet standard technologies. The UltiPro Workforce Management solution was designed to leverage cutting-edge technologies such as XML and Web Services that use open standards to provide customers with a cost-effective platform for performing critical business functions rapidly over the Web and allowing different systems to communicate with one another. The use of Microsoft technology helps the Company to deliver what it believes to be a highly deployable and manageable payroll and workforce management solution that includes the following key technological features:

      Web-Based Technologies and Internet Integration. Ultimate Software supports emerging Web technologies and Internet/extranet connectivity to increase access to and usability of its applications. UltiPro is a Web solution with a back office component for handling such functions as payroll processing, company and system setup, and security. One of the highlights of UltiPro’s technology is the Company’s Distributed Process Management (“DPM”) framework of XML Web Services, a framework that enables business functions to be performed over the Web, and allows different enterprise systems to talk to one another over the Internet. UltiPro’s DPM was designed to automate and distribute HR and payroll processes, for example, entering group time or generating reports, across multiple servers to reduce the amount of time and manual work required. The DPM framework leverages Microsoft’s Component Object Model (COM), eXtensible Markup Language (XML), Simple Object Access Protocol (SOAP), Web Services Definition Language (WSDL) and Microsoft Message Queuing (MSMQ) to improve system speed and performance. The Company believes that the DPM framework makes UltiPro highly scalable to accommodate a high volume of processing requests cost-effectively, particularly for companies that run hundreds or even thousands of payrolls.

      Application Framework. Ultimate Software has designed certain aspects of its system using a multi-tiered architecture in order to enhance the system’s speed, flexibility, scalability and maintainability. When an application’s logic resides only on a client workstation, a user’s ability to process high volume data transactions is limited. When the logic resides only on a server, the user’s interactive capabilities are reduced. To overcome such limitations, Ultimate Software built more separation into the application design to increase the extensibility, scalability and maintainability of the application. The UltiPro Workforce Management application consists of several core components in a layered architecture that leverages Microsoft technology. UltiPro’s multi-layered architecture, including an Operating System Layer, Business Logic Layer, Presentation Layer and User Interface Layer, makes it easier to update and maintain UltiPro, as well as integrate UltiPro with other enterprise systems. The Company believes that UltiPro’s application framework provides a highly extensible set of services that can scale depending on the customer’s business size. In addition, UltiPro was built using a data-driven, object-oriented application framework that enhances the development and usability of the solution. Object-oriented programming features code reusability and visual form/object inheritance, which decrease the time and cost of developing and fully implementing a new system. With object-oriented programming, system updates do not overwrite prior customizations to the system because custom changes are sub-classed objects that reside “outside” the core program.

      Business Intelligence Tools. In addition to an extensive library of standard reports that offer flexibility and ease of use, the Company extends what users can do with employee data by embedding business intelligence tools from Cognos Corporation, a third-party provider (“Cognos”). In addition to offering sophisticated data query and report authoring, these tools enable users to apply online analytical processing

(“OLAP”) to multidimensional data cubes, allowing users to explore data on employees graphically and statistically from diverse angles. Ultimate Software maintains a link between Cognos’ report catalog and UltiPro’s data dictionary, eliminating the necessity for users to create and maintain ad hoc reporting catalogs. A Cognos Web Package is delivered to UltiPro customers to allow users to access reports and conduct data queries from a Web browser.

Ultimate Software Solutions

      Ultimate Software’s core solution, UltiPro Workforce Management, was originally designed for mid-sized enterprise customers, primarily those with 500 to 15,000 employees but is appropriate for and is used by both smaller and larger organizations. Ultimate Software also offers the “Powered by UltiPro” BSP Solution (the “BSP Solution”) with Internet Payroll to business services providers that have relationships with smaller organizations, typically those with fewer than 500 employees and, since 2004, is now available to BSPs to use for very large corporations.

UltiPro Workforce Management Software (“UltiPro”)

      UltiPro Workforce Management is designed to provide customers the functionality they need to manage every aspect of the employee life cycle in one place, from recruiting and hiring to compensating and managing benefits to terminating, whether a customer’s processes are centralized at headquarters or managed by multiple divisions or branch offices. UltiPro’s 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 activities. 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 more efficiently.

      UltiPro Workforce includes, but is not limited to, the following functionality:

      UltiPro’s Workforce Portal. UltiPro’s workforce portal can act as the gateway for a company’s executives, management team, HR/payroll staff, administrators, and employees to business activities. Ultimate Software believes that UltiPro’s workforce portal allows its customers to improve service to their employees through better communications and save time because managers and administrators can complete hundreds of common employee-related tasks, including administering benefits, managing staff and accessing reporting and business intelligence in real-time, from one central location.

      eManager Self-Service. As authorized, managers have self-service access to staff information such as salary, compensation history, key dates and emergency contacts, with reporting and workforce analysis tools to facilitate decision-making. A customer’s managers can view and update staff information, manage department activities, post job openings, leverage recruiting and hiring tools, and perform Web queries on workforce data. UltiPro’s document management features can be used to house and categorize employee-related documents such as drivers’ licenses, consent forms, and completed I-9s with required identification. Administrators and managers have the ability to attach Microsoft Word documents, PDFs, JPEG files, spreadsheets, or any other file types supported by Microsoft Internet Explorer to employee files. The documents can be grouped and sorted to individual requirements, as necessary.

      eEmployee Self-Service. UltiPro eEmployee Self-Service gives a customer’s employees immediate security-protected access to view their own paycheck details and benefits summaries, frequently used forms and company information. They can also update personal information such as address, phone number, emergency contacts and skills; change preferences such as direct deposit accounts and benefits selections; make routine requests such as asking for vacation time; and enroll in training.

      eAdministration. UltiPro’s eAdministration includes eWork Events, eStandard Reporting, and eSystem Administration. eWork Events enables users to authorize HR/payroll staff, managers or supervisors to make updates on the Web through more than 100 pre-defined workflow processes to expedite business activities such as hiring an employee or inputting a salary increase. eStandard Reporting allows authorized managers or

HR/payroll staff to run standard UltiPro reports, including upcoming performance reviews, headcount reports, average salary reports, government compliance reports, general ledger reporting, and other point-in-time HR/payroll reports from the Web without requiring the time of central HR/payroll or IT staff. eSystem Administration was designed for the non-technical user to administer UltiPro’s roles-based security, built-in workflow and system business rules, as well as enable system administrators to post company communications, link to external Web sites from the UltiPro portal, and, through UltiPro’s ePalette feature, select the colors of UltiPro’s Web pages to match the customer’s own company image.

      eHuman Resources. UltiPro tracks HR-related information including employment history, performance, job and salary information, career development, and health and wellness programs. In addition, UltiPro facilitates the recording and tracking of key information for government compliance and reporting, including Consolidated Omnibus Budget Reconciliation Act compliance; Health Insurance Portability & Accountability Act certificates; Occupational Safety & Health Administration and workers’ compensation; Family Medical Leave Act tracking; and Equal Employment Opportunity compliance. UltiPro also ensures compliance with the Health Insurance Portability & Accountability Act confidentiality legislation for protecting sensitive data such as employee social security numbers. eHuman Resources includes benefits administration, recruitment and staffing tools, compensation management and training management functionality.

      Payroll Processing. UltiPro’s payroll engine handles hundreds of payroll-related computations intended to minimize the customer’s need for side calculations or additional programming. For example, UltiPro delivers complex wage calculations such as average pay rates for overtime calculations, shift premiums, garnishments and levy calculations. With ePayroll Processing, a company’s central payroll department, remote offices or multiple divisions can process payroll on the Web in several steps. ePayroll Processing includes eTime Entry to allow customers’ supervisors or managers at branch offices to input and submit time for their team through the Web.

      UltiPro Business Intelligence. Using UltiPro’s Business Intelligence tools, customers can provide their managers and executives with Web access to workforce-related reports, workforce analytics and point-in-time reporting, without installing reporting software on users’ PCs or writing custom reports. With UltiPro Business Intelligence, users can run and print pre-formatted reports for the executive team or run instant queries on the Web for answers to routine questions. UltiPro Business Intelligence also delivers workforce analytics to enable managers to evaluate workforce trends strategically on topics such as compensation, turnover and overtime.

      eTraining Enrollment. With eTraining Enrollment, customers’ employees can view course schedules and descriptions and register online. Managers can also approve staff training requests from the Web.

      eBenefits Enrollment. With eBenefits Enrollment, customers’ employees can review their benefit choices and make selections on the Web. Benefits administrators can set up enrollment sessions from the Web and use tools to monitor enrollment progress. eBenefits Enrollment also walks employees through all of the benefit and personal information changes necessary as a result of a life event such as getting married, having a baby or moving.

      eRecruitment. UltiPro eRecruitment automates, tracks and manages the hiring and recruiting process to help reduce overall “cost per hire” and “time to hire.” With UltiPro eRecruitment, users can post openings to job sites they subscribe to, track applications and hire candidates from within UltiPro’s workforce portal.

      eCo-Branding. For organizations that want to co-brand UltiPro for the purpose of delivering services to a customer base, UltiPro offers eCo-Branding as an extra-cost option. eCo-Branding provides Web access to important personal information for customers’ employees, including the ability to view current paycheck and direct deposit details, paycheck history and benefits details. Customers can display their own company logo with the “Powered by UltiPro” logo to their user base to strengthen their brand.

      Position Management. UltiPro Position Management helps customers manage their resource budget, measure trends and forecast future needs. Users can manage by full-time employee equivalents and dollars, and evaluate budgeted versus actual numbers. Authorized users can check the status of fund allocations, available open positions and staffing requirements. Because HR and payroll are integrated, reporting on position information for budgeted and actual does not require multiple spreadsheets.

      UltiPro Wireless. Ultimate Software recognizes the mobile workforce today and delivers a wireless application geared for today’s mobile employees, managers, administrators and executives. UltiPro Wireless provides employees with access to their paycheck details and company directory via a wireless device. Managers can elect to receive wireless notifications for workflow events requiring their approval (such as an employee vacation request).

      Other Key Features. UltiPro also includes Tax Management to deliver Federal, state and local tax updates automatically every quarter as part of the core solution; Enterprise Integration Tools that provide the ability to interface with third-party applications and providers such as general ledger, tax filing services, time clocks, banks, 401(k) and benefit providers, check printing services and unemployment management services; and Distributed Process Management XML Web Services that batch and distribute HRMS/payroll processes across multiple servers to increase efficiency, reduce the time required to ensure processes are completed, and allow them to be initiated over the Web.

“Powered by UltiPro” BSP Solution (the “BSP Solution”)

      “Powered by UltiPro” BSP Solution is designed for and primarily marketed to business service providers that have relationships with smaller organizations, those with fewer than 500 employees. The BSP Solution enables business service providers to deliver Web-based workforce management and payroll services to their customers and Web-access for their customers’ employees to view their paycheck and basic benefits information. In 2004, Ultimate Software extended its BSP program to allow BSPs that target very large corporations to use UltiPro as part of an HR Outsourcing offering. The very large corporations targeted in this type of offering, generally having more than 10,000 employees would be those that Ultimate Software’s direct sales force would not typically see in the sales process. Business service providers have the opportunity to co-brand UltiPro and to price their offerings on a per-employee-per-month or other monthly basis.

      The BSP Solution has been packaged to be easy to use and convenient for smaller companies and is appropriate for larger companies as well. For the small company market, companies with less than 500 employees, the BSP Solution leverages select functionality from UltiPro Workforce Management, and have a specially designed Web browser interface for payroll administrators to sign up their businesses for the service, enter employee hours worked and submit payroll. If there are no changes to employees’ standard paycheck information, submitting a payroll generally can be done in less than a minute by clicking an icon. With changes, the process generally can take several minutes. The initial process of registering for Web payroll services generally takes less than an hour if the administrator has all the appropriate data available for entry. To ensure the process is rapid and easy for registrants, there is a checklist online with what they need before beginning the signup process. Through a secure, password-protected login, employees can view their current paycheck and direct deposit details, paycheck history, and benefits details such as medical, dental and 401(k) deductions.

Intersourcing Offering

      In 2002, the Company began offering a hosting service, branded Intersourcing, whereby the Company provides the hardware, infrastructure, ongoing maintenance and back-up services for its customers at a BellSouth data center managed by IBM (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 (“Base Hosting”). 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 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.

Research and Development Activities

      Ultimate Software incurs research and development expenses, consisting primarily of software development personnel costs, in the normal course of its business. Such research and development expenses are for enhancements and future betterments to the Company’s existing products and for the development of new products. During 2004, 2003 and 2002, the Company spent $18.3 million, $18.2 million and $17.7 million, respectively, on research and development activities, which corresponds with the related amounts expensed in the consolidated statements of operations during those periods. There were no software costs capitalized in 2004, 2003 or 2002.

Customer Services

      Ultimate Software believes that delivering quality customer services provides the Company with a significant opportunity to differentiate itself in the marketplace and is critical to the comprehensive solution. Ultimate Software provides its customers services in two broad categories: (i) professional services which includes implementation, customer relationship management, and educational services and (ii) customer support services and maintenance.

      Professional Services. Ultimate Software’s professional services include implementation, customer relationship management and educational services. Ultimate Software believes that its implementation services are differentiated from those of other vendors by speed, predictability and completeness. The Company believes that its successful record with rapid implementations is due to its standardized methodology, long-tenured consultants, the large amount of delivered product functionality, and comprehensive conversion and integration tools.

      Ultimate Software has an experienced team of system and functional consultants that are dedicated to assisting customers with rapid implementations. In addition, Ultimate Software provides its customers with the opportunity to participate in formal training programs conducted by its education services team. Training programs are designed to increase customers’ ability to use the full functionality of the product, thereby maximizing the value of customers’ investments. Courses are designed to align with the stages of implementation and to give attendees hands-on experience with UltiPro. Trainees learn such basics as how to enter new employee information, set up benefit plans and generate standard reports, as well as more complex processes such as defining company rules, customizing the system and creating custom reports. The Company maintains training facilities in Atlanta, Georgia; Schaumburg, Illinois; Dallas, Texas; and at its headquarters in Weston, Florida. In addition to offering classes at these facilities, the Company conducts Web-based training and on-site training at customer facilities. After customers have implemented UltiPro and have been turned over to the Company’s customer support and maintenance program, the Company assigns a customer relationship manager to the account to assist customers on an ongoing basis with special projects, including enhancing their existing systems, managing upgrades and writing custom reports. These services, like all of the Company’s professional services, are typically billed on a time and materials basis.

      Customer Support and Maintenance. Ultimate Software offers comprehensive technical support and maintenance services, which have historically been purchased by all of its customers. Ultimate Software’s customer support center has received the Support Center Practices Certification sponsored by the Service Strategies Corporation (SSC) for the sixth consecutive year. This certification recognizes companies that “deliver exceptional service and support to their customers.” Ultimate Software’s customer support services include: software updates that reflect tax and other legislative changes; telephone support 24 hours a day, 7 days a week; unlimited access to the Company’s employee tax center on the World Wide Web; seminars on year-end closing procedures; and periodic newswires. In addition, the Company’s customer support services team maintains a support Web site for its customers and individual representatives attend user-organized user group meetings on a routine basis throughout the United States.

Customers

      As of December 31, 2004, Ultimate Software had licensed its software to more than 1,200 customers that represent approximately 5,000 companies serving in excess of 2 million employees. Ultimate Software’s customers operate in a wide variety of industries, including manufacturing, food services, sports, technology, finance, insurance, retail, real estate, transportation, communications, healthcare and services. During 2004 and 2003, one of the Company’s customers, Ceridian, accounted for 16% and 17%, respectively, of total revenues. Ceridian did not account for more than 10% of total revenues in 2002. No other customer accounted for more than 10% of total revenues in 2004, 2003 or 2002.

Sales and Marketing

      Ultimate Software markets and sells its products and services through its direct sales force, marketing group, and a network of business service provider alliances.

      Direct Sales. Ultimate Software’s direct sales force includes business development vice presidents, directors and managers who have defined territories. The sales cycle begins with a sales lead generated through a national, corporate marketing campaign or a territory-based activity. In one or more on-site visits, sales managers work with application and technical consultants to analyze prospective client needs, demonstrate the Company’s product and, when required, respond to RFPs (Requests for Proposals). The sale is finalized after clients complete their internal sign-off procedures and terms of the contract are negotiated and signed.

      With a license sale, the terms of the Company’s sales contract typically include a license agreement for the product, an annual maintenance agreement, per-day training rates and hourly charges for implementation services. Typical payment terms include a deposit at the time the contract is signed and additional payments upon the occurrence of other specified events such as the implementation of the software and/or specific payment dates designated in the contract. Payment for implementation and training services under the contract is typically made as such services are provided. A service sale is a hosting, or Intersourcing, agreement that typically requires, but is not limited to, a per-employee-per-month fee, setup fees and hourly charges for implementation.

      Business Service Provider (BSP) Network. The BSP network is a co-branding alliance strategy that enables BSPs to co-brand and market UltiPro and/or the BSP Solution primarily to businesses with fewer than 500 employees and, since 2004, is available for very large companies, generally those having more than 10,000 employees, as well. The goal of the program is to extend the Company’s market penetration in markets where the Company’s direct sales force does not have a significant presence and to build a recurring revenue stream through per-employee-per-month pricing.

      Marketing. Ultimate Software supports its sales force with a comprehensive marketing program that includes public relations, advertising, direct mail, trade shows, seminars and Web site maintenance. Working closely with the direct sales force, customers and strategic partners, the marketing team defines positioning strategies and develops a well-defined plan for implementing these strategies. Marketing services include market surveys and research, overall campaign management, creative development, production control, demand generation, results analysis, and communications with field offices, customers and marketing partners.

Intellectual Property Rights

      The Company’s success is dependent in part on its ability to protect its proprietary technology. The Company relies on a combination of copyright, trademark and trade secret laws, as well as confidentiality agreements and licensing arrangements, to establish and protect its proprietary rights. The Company does not have any patents or patent applications pending, and existing copyright, trademark and trade secret laws afford only limited protection. Accordingly, there can be no assurance that the Company will be able to protect its proprietary rights against unauthorized third-party copying or use, which could materially adversely affect the Company’s business, operating results and financial condition.

      Despite the Company’s efforts to protect its proprietary rights, attempts may be made to copy or reverse engineer aspects of the Company’s products or to obtain and use information that the Company regards as proprietary. Moreover, there can be no assurance that others will not develop products that perform comparably to the Company’s proprietary products. Policing the unauthorized use of the Company’s products is difficult. Litigation may be necessary in the future to enforce the Company’s intellectual property rights, to protect the Company’s trademarks, copyrights or trade secrets or to determine the validity and scope of the proprietary rights of others. Such litigation could result in substantial costs and diversion of resources and could have a material adverse effect on the Company’s business, operating results and financial condition.

      As is common in the software industry, the Company from time to time may become aware of third-party claims of infringement by the Company’s products of third-party proprietary rights. While the Company is not currently subject to any such claim, the Company’s software products may increasingly be subject to such claims as the number of products and competitors in the Company’s industry segments grows and the functionality of products overlaps and as the issuance of software patents becomes increasingly common. Any such claim, with or without merit, could result in significant litigation costs and require the Company to enter into royalty and licensing agreements, which could have a material adverse effect on the Company’s business, operating results and financial condition. Such royalty and licensing agreements, if required, may not be available on terms acceptable by the Company or at all.

Competition

      The market for the Company’s products is highly competitive. The Company’s products compete primarily on the basis of technology, delivered functionality and price/performance.

      Ultimate Software’s competitors include (i) large service bureaus, primarily ADP and, to a lesser extent, Ceridian; (ii) companies, such as PeopleSoft/ Oracle and Kronos, that offer human resource management and payroll (“HRMS/payroll”) software products for use on mainframes, client/server environments and/or Web servers; and (iii) the internal payroll/human resources departments of potential customers which use custom-written software. Many of the Company’s competitors or potential competitors have significantly greater financial, technical and marketing resources than the Company. As a result, they may be able to respond more quickly to new or emerging technologies and to changes in customer requirements, or to devote greater resources to the development, promotion and sale of their products than can the Company. In addition, current and potential competitors have established or may establish cooperative relationships among themselves or with third parties to increase the ability of their products to address the needs of the Company’s prospective customers.

Product Liability

      Software products such as those offered by the Company frequently contain undetected errors or failures when first introduced or as new versions are released. Testing of the Company’s products is particularly challenging because it is difficult to simulate the wide variety of computing environments in which the Company’s customers may deploy these products. Despite extensive testing, the Company from time to time has discovered defects or errors in products. There can be no assurance that such defects, errors or difficulties will not cause delays in product introductions and shipments, result in increased costs and diversion of development resources, require design modifications or decrease market acceptance or customer satisfaction with the Company’s products or result in claims by customers against the Company. In addition, there can be no assurance that, despite testing by the Company and by current and potential customers, errors will not be found after commencement of commercial shipments, resulting in loss of or delay in market acceptance, which could have a material adverse effect upon the Company’s business, operating results and financial condition.

Backlog

      Backlog consists of Intersourcing and Base Hosting services sold under signed contracts for which the services have not yet been delivered. At December 31, 2004, the Company had backlog of $26.4 million

compared to $17.9 million as of December 31, 2003. The Company expects to fill $12.4 million of the backlog during 2005. The Company does not believe that backlog is a meaningful indicator of sales that can be expected for any future period. There can be no assurance that backlog at any point in time will translate into revenue in any subsequent period.

Employees

      As of December 31, 2004, the Company employed 456 persons, including 65 in sales and marketing, 110 in professional services, 158 in research and development, 61 in customer support and 62 in finance, information technology and administration. The Company believes that its relations with employees are good. However, competition for qualified personnel in the Company’s industry is generally intense and the management of the Company believes that its future success will depend in part on its continued ability to attract, hire and retain qualified personnel.

Available Information

      The Company’s Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, proxy statements and amendments to those reports and any registration statements, included but not limited to, Form S-3 are available free of charge on our Internet website at www.ultimatesoftware.com as soon as reasonably practicable after such reports are electronically filed with the Securities and Exchange Commission. Information contained on Ultimate Software’s website is not part of this report.

Item 2. Properties

      Ultimate Software’s corporate headquarters, including its principal administrative, marketing, engineering and support operations, are located in three adjacent office buildings in Weston, Florida. The Company leases all the available square footage in two buildings, or approximately 61,000 total square feet, under two leases, each expiring in 2017. In December 2004, the Company purchased, with available cash, all the available square footage of an adjacent building that serves as an extension of the Company’s corporate headquarters, with approximately 5,000 square feet. In addition, the Company presently leases office space for its sales operations in Albany, New York; Atlanta, Georgia; Columbia, Maryland; Dallas, Texas; Detroit, Michigan; Millburn, New Jersey; Nashville, Tennessee; Ridgeland, Mississippi; Seal Beach, California; and Schaumburg, Illinois. Sales operations in other locations are not supported by leased office space. The Company believes that its existing facilities are suitable and adequate for its current operations for the next 12 months. The Company further believes that suitable space will be available as needed to accommodate any expansion of its operations on commercially reasonable terms.

Item 3. Legal Proceedings

      From time-to-time, the Company is involved in litigation relating to claims arising out of its operations in the normal course of business. The Company is not currently a party to any legal proceedings the adverse outcome of which, individually or in the aggregate, could reasonably be expected to have a material adverse effect on the Company’s operating results or financial condition.

Item 4. Submission of Matters to a Vote of Security Holders

      No matters were submitted to a vote of security holders during the fourth quarter of 2004.

PART II

Item 5. Market for the Registrant’s Common Equity and Related Stockholder Matters

      The following table sets forth, for the periods indicated, the high and low sales prices of the Company’s Common Stock, as quoted on the Nasdaq National Market.

      As of February 18, 2005, the Company had approximately 167 holders of record, representing approximately 2,700 stockholder accounts.

      The Company has never declared or paid any cash dividends on its capital stock and does not anticipate paying any cash dividends in the foreseeable future. The Company currently intends to retain future earnings to fund the development and growth of its business. The payment of dividends in the future, if any, will be at the discretion of the Board of Directors. Under the terms of the Company’s revolving line of credit with Silicon Valley Bank, the Company may not pay dividends without the prior written consent of Silicon Valley Bank. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Liquidity and Capital Resources.”

Item 6. Selected Financial Data

      The following selected consolidated financial data is qualified by reference to and should be read in conjunction with “Management’s Discussion and Analysis of Financial Conditions and Results of Operations” and the Company’s Consolidated Financial Statements and Notes thereto included elsewhere in this Form 10-K. The statement of operations data presented below for each of the years in the three-year period ended December 31, 2004 and the balance sheet data as of December 31, 2004 and 2003 have been derived from the Company’s Consolidated Financial Statements included elsewhere in this Form 10-K, which have been audited by KPMG LLP whose report appears elsewhere in this Form 10-K. The statement of operations data below for the years ended December 31, 2001 and December 2000 and the balance sheet data as of December 31, 2002, 2001 and 2000 have been derived from audited consolidated financial statements not included herein.

Item 7. 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 Company 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 due to risks and uncertainties associated with fluctuations in the Company’s quarterly operating results, concentration of the Company’s product offerings, development risks involved with new products and technologies, competition, the Company’s 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 the Company’s filings with the Securities and Exchange Commission. Other factors that may cause such differences include, but are not limited to, those discussed in this Form 10-K, including Exhibit 99.1 hereto. 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.

Executive Summary

      Ultimate Software’s UltiPro Workforce Management Software (“UltiPro”) is a Web-based solution designed to deliver the functionality businesses need to manage the employee life cycle, from recruiting and hiring to compensating and managing benefits to terminating, whether their processes are centralized at headquarters or distributed across multiple divisions or branch offices. The Company’s main sources of revenues include sales from the Intersourcing Offering (defined below), sales of perpetual software licenses for UltiPro (and the related annual maintenance) and sales of services (mostly implementation) related to both Intersourcing and license sales.

      In the past, the Company’s primary business strategy was centered on sales of perpetual software licenses of UltiPro. In an effort to reduce the volatility and unpredictable nature of a business strategy predominantly focused on license sales, the Company introduced Intersourcing as an additional revenue source during 2002.

      In 2002, Ultimate Software began offering hosting services, branded “Intersourcing” by the Company, whereby Ultimate Software provides the hardware, infrastructure, ongoing maintenance and back-up services for its customers at a BellSouth data center managed by IBM. Intersourcing is designed to appeal to those customers that want to minimize their internal technology support requirements for the application and hardware.

      After the introduction of Intersourcing in mid-2002, the sales mix gradually began to shift towards Intersourcing, especially during 2003 and continuing in 2004. Management believes the shift in sales mix helps to produce a more predictable revenue stream by providing recurring revenue and cash from Intersourcing over the related contract periods, typically 24 months. As Intersourcing units are sold, the recurring revenue backlog associated with Intersourcing grows, enhancing the predictability of future revenue streams. For the last six months of 2003, the sales mix for number of units sold began shifting to favor Intersourcing units over license units, with this shift continuing into 2004. During the year ended December 31, 2004, the sales mix (for new units sold) was comprised of approximately 60% Intersourcing units and 40% license units, which reflected a higher concentration of new Intersourcing units sold compared to the same period of 2003, when the sales mix (for new units sold) was comprised of 55% Intersourcing units and 45% license units. The Company expects the sales mix composition to continue to favor Intersourcing during 2005.

      The financial impact of the shift (from sales of license units to a combination of sales of license units and Intersourcing units) relates to (1) the type of revenue recognized and the timing of recognition; (2) the amount of services revenue recognized; and (3) the timing of cash received from the sale.

      When an Intersourcing unit is sold instead of a license unit, license revenue is replaced with recurring revenue. The license revenue which would otherwise have been recognized upfront (assuming all required accounting criteria are met) is replaced with recurring revenue recognized over the contract term (typically 24 months) with such recurring revenue recognition commencing when the customer runs its first “live” payroll (i.e., generally between four and six months from the date of sale). The total revenue from the sale of an average Intersourcing unit sold is usually no less than it would have been if it were a license sale, with the main difference pertaining to the period of recognition (i.e., being spread over a period of time rather than 100% upfront).

      In addition to the change in type of revenue and the timing of revenue recognition, implementation revenue (a component of services revenue) is also impacted by the shift in sales mix to Intersourcing. On average, an Intersourcing unit takes less time to implement than a license unit. Therefore, as the sales mix shifts towards Intersourcing, billable hours for the Company’s implementation services per unit typically decrease.

      Cash is also impacted when an Intersourcing unit is sold instead of a license unit. For a typical license unit sale, the cash due for the license and the first year of annual maintenance is received within 9 months from the contract date. However, when an Intersourcing unit is sold, the cash due from the Intersourcing sale is received over the course of the contract term, typically 24 months. The total cash received from the sale of an average Intersourcing unit sold is usually no less than it would have been if it were a license sale with the main difference pertaining to the period of time in which it is received.

      While making the transition from a business model focused solely on sales of perpetual licenses to a business model that includes both license sales and Intersourcing sales, the Company raised additional capital in 2004 and 2003 to address expected cash needs related to the transition. In May 2004, capital from a private placement of the Company’s common stock, par value $0.01 per share (the “Common Stock”), totaling $14.4 million, net of stock issuance costs, was raised to provide cash to fund future operations based on the Company’s anticipated growth in Intersourcing sales. In 2003, capital from private placements of the Company’s Common Stock, totaling $17.5 million, net of stock issuance costs, was raised to fund 2003 operations (including the impact of the transition toward more sales of Intersourcing units) and to provide cash to fund future operations based on the Company’s anticipated growth in Intersourcing sales.

      As a result of the Company’s recent transition to a sales mix favoring Intersourcing units, a key financial metric used by the Company in measuring future financial performance is new “annual recurring revenues.” New annual recurring revenues represent the expected one-year value from (i) new Intersourcing sales from the Company’s hosted model (including prorated one-time charges); (ii) maintenance revenues related to new license sales; (iii) recurring revenues from new business service providers; and (iv) recurring revenues from additional sales to Ultimate Software’s existing client base. New annual recurring revenues attributable to sales during 2004 were $12.0 million as compared to $9.2 million for 2003.

      Another major component of recurring revenues is subscription revenues generated from the Company’s business service provider (“BSP”) channel. The BSP contributing the most revenues from the BSP Channel during each of 2004, 2003 and 2002 was Ceridian Corporation (“Ceridian”) under the Original Ceridian Agreement (defined below). See also “Overview–Original Ceridian Agreement.”

      As previously disclosed, Ultimate Software and Ceridian signed an agreement in 2001, as amended, granting Ceridian a non-exclusive license to use UltiPro software as part of an on-line offering for Ceridian to market primarily to businesses with less than 500 employees (the “Original Ceridian Agreement”). Ceridian marketed that solution under the name SourceWeb. During December 2004, RSM McGladrey Employer Services (“RSM”) an existing business service provider of Ultimate Software’s, acquired Ceridian’s SourceWeb HR/payroll and self-service product and existing SourceWeb base of small and midsize business customers throughout the United States (the “RSM Acquisition”). The financial terms of the Original Ceridian Agreement have not changed as a result of the RSM Acquisition. Ceridian will continue to be financially obligated to pay Ultimate Software a minimum fee of $500,000 per month with increases of 5% per annum, compounded beginning in January 2006. The aggregate minimum payments that Ceridian is obligated to pay Ultimate Software under the Original Ceridian Agreement over the minimum term of the agreement

are $42.7 million. To date, Ceridian has paid to Ultimate Software a total of $23.0 million under the Original Ceridian Agreement. Ultimate Software expects to continue to recognize a minimum of $642,000 per month in recurring subscription revenues from the Original Ceridian Agreement until its termination. The earliest date that this agreement can be terminated by either party is March 9, 2008 (except for an uncured material breach). The amount of subscription revenue, a component of recurring revenues, recognized under the Original Ceridian Agreement in 2004, totaling $7.7 million, was the same as that recognized in 2003.

      During 2004 and 2003, Ultimate Software entered into services agreements, as amended and extended from time to time, (individually, the “Ceridian Services Agreement” and collectively, the “Ceridian Services Agreements”), with Ceridian. Under the Ceridian Services Agreements, Ceridian was obligated to pay Ultimate Software a total of $3.3 million and $2.3 million in 2004 and 2003, respectively, payable in equal quarterly installments, in exchange for additional services provided by Ultimate Software during the term of the agreements. The 2003 Ceridian Services Agreement expired effective December 31, 2003 and was recognized on a straight-line basis from February 10, 2003 through December 31, 2003. The 2004 Ceridian Services Agreement, as extended from time to time during 2004, expired on December 31, 2004 and was recognized on a straight-line basis from January 1, 2004 through December 31, 2004. The Company offers and provides certain services to other BSPs.

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:

Perpetual Licenses for UltiPro Sold With or Without Hosting Services

      Sales of perpetual licenses for UltiPro and sales of perpetual licenses for UltiPro in conjunction with Hosting Services are multiple-element arrangements that involve the sale of software and consequently fall under the guidance of Statement of Position (“SOP”) 97-2, “Software Revenue Recognition,” 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 SOP 97-2, license revenues are generally recognized when (1) a non-cancelable license agreement has been signed by both parties, (2) the product has been shipped, (3) no significant vendor obligations remain and (4) collection of the related receivable is considered probable. To the extent any one of these four criteria is not satisfied, license revenue is deferred and not recognized in the consolidated statements of operations until all such criteria are met.

      For multiple-element software arrangements, each element of the arrangement is analyzed and the Company allocates a portion of the total fee under the arrangement to the elements based on vendor-specific objective evidence of fair value of the element (“VSOE”), regardless of any separate prices stated within the contract for each element. Fair value is considered the price a customer would be required to pay when the element is sold separately.

      The Residual Method (as defined below) is used to recognize revenue when a license agreement includes one or more elements to be delivered at a future date and VSOE of the fair value of all undelivered elements exists. The fair value of the undelivered elements is determined based on the historical evidence of stand-alone sales of these elements to third parties. Undelivered elements in a license arrangement typically include maintenance, training and implementation services (the “Standard Undelivered Elements”). The fair value for maintenance fees is based on the price of the services sold separately, which is determined by the annual renewal rate historically and consistently charged to customers (the “Maintenance Valuation”). Maintenance fees are generally priced as a percentage of the related license fee. The fair value for training services is based on standard pricing (i.e., rate per training day charged to customers for class attendance), taking into consideration stand-alone sales of training services through year-end seminars and historically consistent pricing for such services (the “Training Valuation”). The fair value for implementation services is based on standard pricing (i.e., rate per hour charged to customers for implementation services), taking into consideration stand-alone sales of implementation services through special projects and historically consistent pricing for such services (the “Implementation Valuation”). Under the residual method (the “Residual Method”), the fair value of the undelivered elements is deferred and the remaining portion of the arrangement fee attributable to the delivered element, the license fee, is recognized as revenue. If VSOE for one or more undelivered elements does not exist, the revenue is deferred on the entire arrangement until the earlier of the point at which (i) such VSOE does exist or (ii) all elements of the arrangement have been delivered.

      Perpetual licenses of UltiPro sold without Hosting Services typically include a license fee and the Standard Undelivered Elements. Fair value for the Standard Undelivered Elements is based on the Maintenance Valuation, the Training Valuation and the Implementation Valuation. The delivered element of the arrangement, the license fee, is accounted for in accordance with the Residual Method.

      Perpetual licenses of UltiPro sold with Hosting Services typically include a license fee, the Standard Undelivered Elements and Hosting Services. Fair value for the Standard Undelivered Elements is based on the Maintenance Valuation, the Training Valuation and the Implementation Valuation. Hosting Services are delivered to customers on a PEPM basis over the term of the related customer contract (“Hosting PEPM Services”). Upfront fees charged to customers represent fees for the hosting infrastructure, including hardware costs, third-party license fees and other upfront costs incurred by the Company in relation to providing such services (“Hosting Upfront Fees”). Hosting PEPM Services and Hosting Upfront Fees (collectively, “Hosting Services”) represent undelivered elements in the arrangement since their delivery is over the course of the related contract term. The fair value for Hosting Services is based on standard pricing (i.e., rate charged per-employee-per-month), taking into consideration stand-alone sales of Hosting Services through the sale of such services to existing customers (i.e., those who already own the UltiPro perpetual license at the time Hosting Services are sold to them) and historically consistent pricing for such services (the “Hosting Valuation”). The delivered element of the arrangement, the license fee, is accounted for in accordance with the Residual Method.

      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 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 and 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 its 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. Fair value for Professional Services is based on the respective Training Valuation and Implementation Valuation. If evidence of the fair value of one or more undelivered elements does not exist, the revenue is deferred and recognized when delivery of those elements occurs or when fair value can be established. The Company believes that applying EITF 00-21 to Intersourcing arrangements as opposed to applying SOP 97-2 is appropriate given the nature of the arrangements whereby the customer has no right to the UltiPro license.

Sales of Base Hosting Services

      Subscription revenues generated from Base Hosting are recognized in accordance with EITF 00-3, “Application of AICPA Statement of Position 97-2 to Arrangements that Include the Right to Use Software that 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 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 on the Hosting Valuation. The fair value for implementation services is based on standard pricing (i.e., rate per hour charged to customers for implementation services), taking into consideration stand-alone sales of implementation services through special projects and historically consistent pricing for such services (the “Implementation Valuation”). Fair value for implementation services is assigned in accordance with guidelines provided by SOP 97-2 based on the Implementation Valuation.

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 those related to the Ceridian Services Agreements through December 31, 2004, 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 depending on the specific terms of the arrangement.

      Arrangement fees related to fixed-fee implementation services contracts are recognized using the percentage of completion accounting method, which involves the use of estimates. Percentage of completion is measured at each reporting date based on hours incurred to date compared to total estimated hours to complete. 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 PEPM fees earned through the Intersourcing Offering, Base Hosting and the BSP sales channel, as well as revenues generated from the Original Ceridian Agreement. Maintenance revenues are recognized ratably over the service period, generally one year. Maintenance and support fees are generally priced as a percentage of the initial license fee for the underlying products. To the extent there are upfront fees associated with the Intersourcing Offering, Base Hosting or the BSP sales channel, subscription revenues are recognized ratably over the term of the related contract upon the delivery of the product and services. In the cases of Intersourcing and Base Hosting sales, amortization of the upfront fees commences when the customer processes its first Live payroll, which typically occurs four to six months after the sale, and extends until the end of the contract period. In the case of BSP channel sales, amortization of the upfront fee typically commences when the contract is signed, which is when the BSP’s rights under the agreement begin, continuing until the contract term ends. PEPM fees from the Intersourcing Offering, Base Hosting and the BSP sales channel are recognized as subscription revenue as the services are delivered. 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 Agreement). Subscription revenues of $642,000 per month are based on guaranteed minimum payments from Ceridian of approximately $42.7 million over the minimum contract term, including $23.0 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 guaranteed monthly minimum amount for the term of the related agreement. Revenue is recognized on a per-employee-per-month basis. To the extent the BSP pays the Company a one-time upfront fee, the Company accounts for such fee by recognizing it as subscription revenue over the minimum term of the related agreement.

      The Company recognizes revenue in accordance with the Securities Exchange Commission (“SEC”) Staff Accounting Bulletin No. 101, “Revenue Recognition in Financial Statements” (“SAB No. 101”) and the SEC Staff Accounting Bulletin No. 104, “Revenue Recognition” (“SAB No. 104”). Management believes the Company is currently in compliance in all material aspects with the current provisions set forth in SOP 97-2, SOP 98-9, EITF 00-21, EITF 00-3, SAB No. 101 and SAB No. 104.

Concentration of Revenues

      During the years ended December 31, 2004 and 2003, Ceridian accounted for 15.5% and 16.6%, respectively, of total revenues. Ceridian did not account for more than 10% of total revenues in 2002. No other customer accounted for more than 10% of total revenues in the periods presented. Due to the significant concentration of total revenues with this single customer, the Company has exposure if this customer loses its credit worthiness. The Ceridian Services Agreements, under which services revenues were recognized in 2004 and 2003, have terminated and no further services revenues will be recognized with respect to them. See Note 3 of the Notes to Consolidated Financial Statements.

      The composition of the revenues recognized from Ceridian, as a percentage of total revenues, for the years ended December 31, 2004, 2003 and 2002 was as follows:

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 receivable. 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.

Overview

      Ultimate Software designs, markets, implements and supports payroll and workforce management solutions.

      Ultimate Software’s UltiPro Workforce Management Software (“UltiPro”) is a Web-based solution designed to deliver the functionality businesses need to manage the employee life cycle, from recruiting and hiring to compensating and managing benefits to terminating, whether 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 self-service Web portal for executives, managers, administrators, and employees to review and update work-related and personal information. Ultimate Software believes that UltiPro helps customers streamline HR and payroll processes to significantly reduce administrative and operational costs, while also empowering executives and staff to 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 primarily on companies with more than 500 employees and sells both a license model (typically in-house) and a service model (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, since 2004, very large companies, generally those with over 10,000 employees, as well. The Company’s BSP alliances typically sell an Internet solution, which includes UltiPro, priced on a monthly/service basis. When the BSP sells its Internet solution, incorporating UltiPro in the offering, the BSP is obligated to remit a fee to the Company, typically measured on a per-employee-per-month basis and, in some cases, subject to a guaranteed monthly minimum amount.

      The Company’s direct sales force markets UltiPro as an in-house human resources, payroll and workforce management solution and alternatively as a hosted offering branded “Intersourcing” (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 want to focus on their core competencies to increase sales and profits. Through the Intersourcing model introduced in 2002, the Company provides the hardware, infrastructure, ongoing maintenance and backup services for its customers at a BellSouth data center managed by International Business Machines (“IBM”).

Intersourcing Offering

      In 2002, the Company began offering a hosting service, branded Intersourcing, whereby the Company provides the hardware, infrastructure, ongoing maintenance and back-up services for its customers at a BellSouth data center, which is managed by IBM. Different types of hosting arrangements include the sale of hosting services as a part of the Intersourcing Offering, discussed below, and, to a lesser extent, the sale of hosting services to customers that license UltiPro on a perpetual basis. Hosting services, typically available in a shared environment, provide Web access to comprehensive workforce management functionality for organizations that need to simplify the IT support requirements of their business applications and are priced on a per-employee-per-month basis. In the shared environment, Ultimate Software provides an infrastructure with applicable servers shared among many customers who use a Web browser to access the application software through the data 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, typically in a shared environment. The pricing for Intersourcing, including both the hosting element as well as the right to use UltiPro, is on a per-employee-per-month basis.

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

      Under the agreement, Ceridian is responsible for all marketing costs and expenses, and must sell the licensed software on a per period, per employee, per paycheck basis or other repetitive payment model. Ceridian is required to pay the Company a monthly license fee based on the number of employees paid using the licensed software. These payments are subject to a minimum monthly payment of $500,000 per month with increases of 5% per annum, compounded beginning in January 2006. The maximum monthly payment is $1.0 million, subject to increases of 5% per annum, compounded. 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 $23.0 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. Ceridian retains certain rights to use the software upon termination.

      During December 2004, RSM McGladrey Employer Services (“RSM”), an existing business service provider of Ultimate Software’s, acquired Ceridian’s SourceWeb HR/payroll and self-service product and

existing SourceWeb base of small and midsize business customers throughout the United States (the “RSM Acquisition”). The financial terms of the Original Ceridian Agreement have not changed as a result of the RSM Acquisition. Ceridian will continue to be financially obligated to pay Ultimate Software a minimum fee of $500,000 per month with increases of 5% per annum, compounded beginning in January 2006. Ultimate Software expects to continue to recognize a minimum of $642,000 per month in recurring subscription revenues from the Original Ceridian Agreement until its termination.

Ceridian Services Agreements

      On April 7, 2004, the Company and Ceridian extended their services agreement, which expired on December 31, 2003 (the “Extended Ceridian Services Agreement”). Under the Extended Ceridian Services Agreement, which was effective January 1, 2004 through September 30, 2004, Ceridian was obligated to pay Ultimate Software a total of $2.5 million in three equal installments in exchange for services provided by Ultimate Software during the term of that agreement. All three installment payments due under the Extended Services Agreement were received by the Company through July 2004. During October 2004, the Extended Ceridian Services Agreement was further extended until December 31, 2004 for a fee of $0.8 million, received in a single installment in November 2004. Services revenue from the Extended Ceridian Services Agreement was recognized on a straight-line basis from January 1, 2004 through December 31, 2004. The Extended Ceridian Services Agreement expired on December 31, 2004 and was not renewed. The Company offers and provides certain services to other BSPs.

Results of Operations

      The following table sets forth the Statements of Operations data of the Company, as a percentage of total revenues, for the periods indicated.

Comparison of Fiscal Years Ended December 31, 2004 and 2003

Revenues

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

      Recurring revenues include annual maintenance on software license agreements for the Company’s products 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. To the extent there are upfront fees associated with the Intersourcing Offering, Base Hosting or the BSP sales channel, subscription revenues are recognized ratably over the term of the related contract upon the delivery of the product and services. PEPM fees from the Intersourcing Offering, Base Hosting and the BSP sales channel are recognized as subscription revenues as the services are delivered. All of the Company’s customers that purchased software during 2004 and 2003 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.

      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 services provided to BSPs, including those related to the Ceridian Services Agreement (which expired on December 31, 2004), the provision of payroll-related forms and the printing of Form W-2’s for certain customers and certain reimbursable out-of-pocket expenses. Revenues for training and implementation consulting services are recognized as services are performed. Revenues for the Ceridian Services Agreement were recognized ratably based on the terms of the agreement, from January 1, 2004 through December 31, 2004. Other services are recognized as the product is shipped or as the services are rendered.

      License revenues include revenues from software license agreements for the Company’s products, entered into between the Company and its customers in which the license fees are non-cancelable. License revenues are generally recognized upon the delivery of the related software product when all significant contractual obligations have been satisfied. Until such delivery, the Company records amounts received when contracts are signed as customer deposits which are included with deferred revenues in the consolidated balance sheets.

      Total revenues, consisting of recurring, services and license revenues, increased 19.2% to $72.0 million for 2004 from $60.4 million for 2003.

      Recurring revenues increased 33.1% to $39.0 million for 2004 from $29.3 million for 2003 primarily due to a total increase of $6.5 million in revenues generated from the Intersourcing Offering resulting from incremental Intersourcing units sold and an increase in the number of Intersourcing customers that processed their first live payroll during 2004 combined with additional maintenance revenues generated from incremental licenses sold. Recurring subscription revenues recognized in 2004 from the Original Ceridian Agreement, totaling $7.7 million, were the same as in 2003. Beginning on August 28, 2002, subscription revenues generated from the Original Ceridian Agreement of $642,000 per month have been recognized, and are expected to be recognized, over the minimum term of the contract. 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. Future recurring revenues to be recognized from the Original Ceridian Agreement are expected to be comparable to 2004, or $7.7 million per year through March 9, 2008. 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 increased 6.2% to $24.9 million for 2004 from $23.5 million for 2003 primarily as a result of an increase of $1.1 million in services revenue generated from the Extended Ceridian Services

Agreement and an increase of $0.5 million in implementation revenues, partially offset by a decrease of $0.3 million in certain reimbursable out-of-pocket expenses.

      License revenues increased 6.1% to $8.0 million for 2004 from $7.6 million for 2003 primarily due to a higher average selling price in 2004 as unit sales were comparable.

Cost of Revenues

      Cost of revenues consists of the cost of recurring, services and license revenues. Cost of recurring revenues consists of costs to provide maintenance and technical support to the Company’s customers, the cost of providing periodic updates and the cost of subscription revenues, including amortization of capitalized software. Cost of services revenues primarily consists of costs to provide implementation services and training to the Company’s customers and, to a lesser degree, costs related to sales of payroll-related forms, costs associated with certain reimbursable out-of-pocket expenses, discussed below, and costs to support additional services provided to BSPs. 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 increased 26.0% to $12.0 million for 2004 from $9.5 million for 2003. The $2.5 million increase in cost of recurring revenue for 2004 was attributable to additional costs associated with the growth in the Intersourcing Offering, including labor costs, depreciation and amortization of related computer equipment and costs associated with the BellSouth data center. As a percentage of recurring revenues, cost of recurring revenues decreased to 30.6% for 2004 from 32.4% for 2003 primarily due to the absorption of these expenses in an expanded recurring revenue base.

      Cost of services revenues increased 6.8% to $18.4 million for 2004 from $17.3 million for 2003 primarily as a result of increased costs to provide additional services to BSPs, principally labor-related, and higher implementation and training costs, partially offset by a decrease in certain reimbursable out-of-pocket expenses. Cost of services revenues, as a percentage of services revenues, increased to 74.0% for 2004 from 73.6% for 2003 primarily as a result of higher expenses.

      Cost of license revenues increased 23% to $1.0 million for 2004 from $0.8 million for 2003. The increase in cost of license revenues for 2004 was due to increased labor costs and additional third-party royalty fees, partially offset by a reduction in the amortization of capitalized software. Capitalized software impacting the cost of license revenues were fully amortized as of July 31, 2004. As a percentage of license revenues, cost of license revenues increased to 12.3% for 2004 from 10.6% for 2003 primarily as a result of a disproportionate increase in the cost of licenses in comparison to the increase in the license revenue base. 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 labor costs and the amortization of capitalized software.

Sales and Marketing

      Sales and marketing expenses consist primarily of salaries and benefits, sales commissions, travel and promotional expenses, and facility and communication costs for direct sales offices, as well as advertising and marketing costs. Sales and marketing expenses increased 16.0% to $20.6 million for 2004 from $17.8 million for 2003. The increase in sales and marketing expenses was primarily due to a $2.3 million increase in labor costs and, to a lesser extent, an increase in advertising and marketing costs of $0.5 million. The main contributing factors for the increase in labor costs in 2004 were sales commissions and salaries, benefits and travel costs. The increase in sales commissions was predominantly related to the increase in recurring revenues from Intersourcing, which are amortized over the initial term of the contracts, usually two years, commencing when the customer processes its first Live payroll. The addition of personnel to the sales infrastructure during

the three months ended September 30, 2003 was the primary cause for the increase in salaries, benefits and travel costs in 2004.

Research and Development

      Research and development expenses consist primarily of software development personnel costs. Research and development expenses of $18.3 million in 2004 were consistent with expenses of $18.2 million in 2003 with 2004 labor costs increasing slightly over 2003.

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 15.9% to $6.8 million for 2004 from $5.9 million for 2003 primarily due to an increase of $0.6 million principally related to additional external professional fees associated with Sarbanes-Oxley Section 404 compliance and an increase of $0.2 million in the provision for doubtful accounts.

Interest Expense

      Interest expense decreased 17.6% to $182,000 for 2004 from $221,000 for 2003 primarily due to the reduction in borrowings from the Credit Facility, defined below.

Interest and Other Income

      Interest and other income increased 176.7% to $285,000 for 2004 from $103,000 for 2003 primarily due to interest income on cash available for investments.

Provision for Income Taxes

      No provision or benefit for Federal, state or foreign income taxes was made for 2004 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, 2004, expiring at various times through the year 2024 and which are available to offset future taxable income, were $62.9 million. The timing and levels of future profitability may result in the expiration of net operating loss carryforwards before utilization. Additionally, utilization of such net operating losses may be limited as a result of cumulative ownership changes in the Company’s equity instruments.

Comparison of Fiscal Years Ended December 31, 2003 and 2002

Revenues

      Total revenues, consisting of recurring, services and license revenues, increased to $60.4 million for 2003 from $55.1 million for 2002.

      Recurring revenues increased 51.7% to $29.3 million for 2003 from $19.3 million for 2002 primarily due to an increase of $5.0 million in subscription revenues recognized under the Original Ceridian Agreement, and a $4.7 million increase in recurring revenues generated from the Intersourcing Offering resulting from additional Intersourcing units sold and maintenance revenues generated from incremental licenses sold. During 2003, there was an increase of $5.0 million in recurring revenues from the Original Ceridian Agreement in comparison to 2002. This increase was a result of the duration of revenue recognition in 2003 versus 2002 — in 2003, a full year of recurring revenues was recognized whereas in 2002 slightly more than four months of recurring revenues was recognized. Beginning on August 28, 2002, subscription revenues generated from the Original Ceridian Agreement of $642,000 per month have been, and are expected to be, recognized over the minimum term of the contract, which is expected to extend until March 9, 2008. Future recurring revenues to be recognized from the Original Ceridian Agreement are expected to be comparable to 2003, or $7.7 million per year, through March 9, 2008.

      Services revenues decreased 0.7% to $23.5 million for 2003 from $23.6 million for 2002 primarily as a result of a decrease in implementation revenues of $2.7 million primarily resulting from fewer billable hours in 2003 principally caused by the shift towards Intersourcing units, which generally require less time to implement than license units, partially offset by an increase of $2.3 million in services revenue generated from the Ceridian Services Agreement, which were recognized ratably from February 10, 2003 through December 31, 2003.

      License revenues decreased 37.6% to $7.6 million for 2003 from $12.2 million for 2002. The decrease in license revenues was due to the combination of fewer license units sold, principally due to a shift in targeted sales (i.e., a sales mix which includes more Intersourcing units sold), and a decrease in sales of UltiPro to existing clients using the Company’s discontinued 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. In 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.

Cost of Revenues

      Cost of recurring revenues increased 17.3% to $9.5 million for 2003 from $8.1 million for 2002. The $1.4 million increase in cost of recurring revenue for 2003 was primarily attributable to additional costs associated with the Intersourcing Offering, including depreciation and amortization of related computer equipment and costs associated with the BellSouth data center, and higher costs of maintenance revenues principally due to increased labor costs, including benefits. As a percentage of recurring revenues, cost of recurring revenues decreased to 32.4% for 2003 from 41.9% for 2002 primarily due to the absorption of these expenses in an expanded recurring revenue base.

      Cost of services revenues decreased 5.4% to $17.3 million for 2003 from $18.3 million for 2002. The decrease was due to a decrease of $0.7 million in costs of implementation, principally from lower third-party consultant fees and, to a lesser extent, a reduction in performance-based bonuses paid to Ultimate Software’s consultants in 2003. Cost of services revenues, as a percentage of services revenues, decreased to 73.6% for 2003 from 77.3% for 2002 primarily as a result of lower expenses.

      Cost of license revenues decreased 30.6% to $0.8 million for 2003 from $1.2 million for 2002. The decrease in cost of license revenues for 2003 was due to lower third-party royalty fees resulting from fewer licensed units sold and a reduction in the amortization of capitalized software. As a percentage of license revenues, cost of license revenues increased to 10.6% for 2003 from 9.6% for 2002 primarily as a result of a decreased license revenue base. 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 labor costs and the amortization of capitalized software.

Sales and Marketing

      Sales and marketing expenses increased 1.8% to $17.8 million for 2003 from $17.5 million for 2002. The increase in sales and marketing expenses was primarily due to a $0.8 million increase in labor costs, excluding sales commissions, and an increase in advertising and marketing costs of $0.2 million, partially offset by a decrease of $0.7 million attributable to lower sales commissions tied to the decrease in license revenues. The addition of personnel to the sales infrastructure during the three months ended September 30, 2003 was the main contributing factor for the increase in labor costs in 2003.

Research and Development

      Research and development expenses increased 3.1% to $18.2 million for 2003 from $17.7 million for 2002. The increase in 2003 was due to increased labor costs of $0.8 million principally resulting from increased benefit costs and additional personnel 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.

General and Administrative

      General and administrative expenses decreased 14.8% to $5.9 million for 2003 from $6.9 million for 2002 primarily due to a $1.4 million reduction in the provision for doubtful accounts, partially offset by increased labor costs of $0.5 million. The provision for doubtful accounts decreased to $0.2 million for 2003 from $1.7 million in 2002. This decrease was primarily attributable to three factors: (1) a decrease of $1.6 million in the balance of accounts receivable, gross of the allowance for doubtful accounts; (2) a decrease of $2.4 million in individual accounts charged-off during 2003 as compared to 2002; and (3) a decrease of $0.5 million in the allowance for doubtful accounts. The balance of gross accounts receivable declined principally due to a shift in targeted sales (i.e., a sales mix which includes more Intersourcing units sold). Intersourcing units typically have a shorter payment period than license units. Charge-offs were lower in 2003 due to the improvement in the quality of composition of the Company’s accounts receivable portfolio. The allowance for doubtful accounts decreased as a result of the combination of the lower gross accounts receivable balance and the improvement of the quality of the composition of the accounts receivable portfolio in 2003 as compared to 2002.

Interest Expense

      Interest expense decreased 21.9% to $221,000 for 2003 from $283,000 for 2002 primarily due to the payoff of outstanding borrowings under the Credit Facility (defined below) during September 2003.

Interest and Other Income

      Interest and other income decreased 25.4% to $103,000 for 2003 from $138,000 for 2002 primarily due to the reduction in funds available for investment during the first half of 2003.

Provision for Income Taxes

      No provision or benefit for Federal, state or foreign income taxes was made for 2003 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, 2003, expiring at various times through the year 2023 and which are available to offset future taxable income, were $56.6 million. The timing and levels of future profitability may result in the expiration of net operating loss carryforwards before utilization. Additionally, utilization of such net operating losses may be limited as a result of cumulative ownership changes in the Company’s equity instruments.

Quarterly Results of Operations

      The following table sets forth certain unaudited quarterly results of operations for each of the quarters in the years ended December 31, 2004 and 2003. In management’s opinion, this unaudited information has been prepared on the same basis as the audited consolidated financial statements and includes all adjustments (consisting only of normal recurring adjustments) necessary for a fair presentation of the information for the quarters presented. This information should be read in conjunction with the Company’s Consolidated Financial Statements and Notes thereto, included elsewhere in this Form 10-K.

      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.

Liquidity and Capital Resources

      The Company has historically funded operations primarily through the private and public sale of equity securities and, to a lesser extent, equipment financing and borrowing arrangements.

      As of December 31, 2004, the Company had $25.3 million in cash, cash equivalents and investments in marketable securities, reflecting a net increase of $11.5 million since December 31, 2003. As of December 31, 2004, the Company had working capital of $3.7 million as compared to a working capital deficit of $5.2 million as of December 31, 2003. The increase in working capital resulted primarily from the additional equity raised in 2004, partially offset by the funding of operations.

      Net cash provided by operating activities was $0.3 million for 2004 as compared to net cash used in operating activities of $8.7 million for 2003. The increase in net cash provided by operating activities was primarily due to cash received from Ceridian of $5.5 million, in accordance with the payment terms of the

Original Ceridian Agreement, partially offset by an increase in accounts receivable. 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, and the Company received $0.5 million in September 2002 for the early delivery of the general release, UltiPro 6.0 (also known as “Evolution”). During 2003, the Company did not receive any cash from Ceridian under the Original Ceridian Agreement. Guaranteed minimum payments from Ceridian under the Original Ceridian Agreement of $500,000 per month resumed effective January 1, 2004. As of the date of this Form 10-K, the Company has received $1.0 million from Ceridian during 2005 pursuant to the payment terms of the Original Ceridian Agreement. In addition, during 2004, the Company received an additional $0.8 million from Ceridian pursuant to the Extended Ceridian Services Agreement, which expired on December 31, 2004.

      Net cash used in investing activities was $15.3 million for 2004 as compared to $2.3 million for 2003. The increase in net cash used in investing activities was primarily due to investing in marketable securities available-for-sale and an increase in purchases of property and equipment, including additional equipment purchases associated with the Intersourcing operations and the cash purchase in December 2004 of a 5,000 square foot building adjacent to the Company’s headquarters which is being used to accommodate the growth in the Company’s operations, partially offset by decrease in acquisitions.

      Net cash provided by financing activities was $16.0 million for 2004 as compared to $15.8 million for 2003. The increase in net cash provided by financing activities in 2004 as compared to 2003 was primarily related to increased borrowings under the equipment line of the Credit Facility, partially offset by a $1.6 million decrease in net proceeds from issuances of the Company’s common stock, $0.01 par value per share (“Common Stock”) due to the combination of lower net proceeds from private sales of Common Stock and higher net proceeds from exercises of options to purchase Common Stock. For the year ended December 31, 2004, the Company had net borrowings of $0.4 million under the equipment line under the Credit Facility whereas in the year ended December 31, 2003, the Company had net repayments of $1.3 million under the Credit Facility.

      Days sales outstanding, calculated on a trailing three-month basis (“DSO”), as of December 31, 2004 and 2003, were 57 days and 52 days, respectively. The increase in DSO’s as of December 31, 2004 was the result of an increase in accounts receivable attributable to higher license sales and certain BSP sales.

      Deferred revenue was $28.5 million at December 31, 2004 as compared to $24.6 million at December 31, 2003. The increase of $3.9 million in deferred revenue was primarily due to the combination of higher deferred Intersourcing revenues which are recognized over the term of the related contract and higher deferred revenue from several new BSP sales which are also recognized over the related contract term, partially offset by non-cash amortization of $1.7 million under the Original Ceridian Agreement.

      On May 12, 2004, the Company entered into a definitive agreement to sell 1,398,182 newly issued shares of its Common Stock to three institutional investors in a private placement for gross proceeds of approximately $15.4 million (the “Recent Capital Raised”). These shares of Common Stock were sold at $11.00 per share. After deducting commissions and other stock issuance costs, the Company received approximately $14.4 million. The Company is using the net proceeds from the Recent Capital Raised for general corporate purposes, including working capital and funding the Company’s transition from a license model to a business model with a higher percentage of recurring revenues. The Company filed a registration statement with the Securities and Exchange Commission on Form S-3 (Registration No. 333-115894) covering resales of the Common Stock by investors, which registration statement was declared effective on June 25, 2004.

      On July 16, 2003, the Company sold 2,200,000 newly issued shares of its Common Stock to two institutional investors in a private placement for gross proceeds of approximately $11.7 million. These shares of Common Stock were sold at $5.30 per share. After deducting commissions and other stock issuance costs, the Company received approximately $10.6 million. The Company filed a registration statement with the Securities and Exchange Commission on Form S-3 (Registration No. 333-107527) covering resales of the Common Stock by investors, which registration statement was declared effective on December 9, 2003.

Certain other shareholders exercised their right to include shares owned by them in such registration statement on Form S-3.

      In addition to the July 16, 2003 private placement, during 2003 the Company sold an aggregate of 1,708,000 newly issued shares of Common Stock and warrants to purchase 170,800 shares of Common Stock at $4 per share to a group of investors, including Ceridian and some existing shareholders, for gross proceeds of $6.8 million.

      The Company’s primary motive for raising additional capital in 2004 and 2003 was to fund the transition in its business model which shifts some of its UltiPro unit sales to Intersourcing. Management believes the shift in sales mix helps to produce a more predictable revenue stream by providing recurring revenue and cash from Intersourcing over the related contract periods, typically 24 months. As Intersourcing units are sold, the recurring revenue backlog associated with Intersourcing grows, providing visibility for the future and enhancing the predictability of future revenue streams.

      In November 2001, the Company entered into a $5.0 million revolving line of credit (the “Credit Facility”) with Silicon Valley Bank. The Credit Facility, as amended, expires on May 27, 2005 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, as defined). The Credit Facility provides working capital financing for up to 75% of the Company’s eligible accounts receivable not to exceed $3.0 million (the “Revolving Note”), as defined, stand-by letters of credit for up to $0.5 million as a component of the Revolving Note and financing for eligible equipment purchases for up to $2.0 million with additional limits for software purchases (the “Equipment Term Note”). The Equipment Term Note is payable in 36 equal monthly installments, plus interest at Prime Rate plus 1%. The maximum amount available under the Credit Facility is $5.0 million. At December 31, 2004, $4.5 million was available for borrowing under the Credit Facility with $0.4 million outstanding under the Equipment Term Note.

      Borrowings under the Credit Facility are secured by all of the Company’s corporate assets, including a negative pledge on intellectual property, and the Company is required to comply with certain financial and other covenants. Under the terms of the Credit Facility, the Company may not pay dividends without the prior written consent of Silicon Valley Bank. The material covenants require that the Company maintain, on a monthly basis, a minimum quick ratio (representing the ratio of current assets to current liabilities, excluding deferred revenue) of 1.75 to 1.0 and certain quarterly revenue levels as of the end of each quarter, as provided in the Credit Facility, as amended. As of December 31, 2004, the Company was in compliance with all covenants included in the terms of the Credit Facility.

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

Recent Accounting Literature

      In December 2004, the FASB issued SFAS No. 123 (revised 2004), “Share-Based Payment” (“SFAS 123R”), which replaces SFAS No. 123, “Accounting for Stock-Based Compensation” (“SFAS 123”) and supercedes APB Opinion No. 25, “Accounting for Stock Issued to Employees.” SFAS 123R requires all share-based payments to employees, including grants of employee stock options, to be recognized in the financial statements based on their fair values and the recording of such expense in the consolidated statements of income. The accounting provisions of SFAS 123R are effective for reporting periods beginning after June 15, 2005. The pro forma disclosures previously permitted under SFAS 123, no longer will be an alternative to financial statement recognition. The Company is required to adopt SFAS 123R in the third quarter of fiscal 2005. Under SFAS 123R, the Company must determine the appropriate fair value model to be used for valuing share-based payments, the amortization method for compensation cost and the transition method to be used at date of adoption. The Company is evaluating the requirements of SFAS 123R and expects that the adoption of SFAS 123R will have a material impact on the consolidated results of operations and earnings per share. The Company has not yet determined the method of adoption or the effect

of adopting SFAS 123R, and has not determined whether the adoption will result in amounts that are similar to the current pro forma disclosures under SFAS 123 in Note 2 of the Notes to Consolidated Financial Statements.

      In December 2003, the FASB issued a revised Interpretation No. 46, “Consolidation of Variable Interest Entities, an interpretation of Accounting Research Bulletin No. 51,” (“FIN 46R”). FIN 46R requires the consolidation of entities in which an enterprise absorbs a majority of the entity’s expected losses, receives a majority of the entity’s expected residual returns, or both, as a result of ownership, contractual or other financial interests in the entity. Currently entities are generally consolidated by an enterprise when it has a controlling financial interest through ownership of a majority voting interest in the entity. The provisions of FIN 46R are generally effective for existing (prior to February 1, 2003) variable interest relationships of a public entity no later than the end of the first reporting period that ends after March 15, 2004. However, prior to the required application of this interpretation a public entity that is not a small business issuer shall apply FIN 46R to those entities that are considered to be special-purpose entities no later than the end of the first reporting period that ends after December 15, 2003. The adoption of FIN 46R did not have an impact on the Company’s consolidated financial statements.

Off-Balance Sheet Arrangements

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

Contractual Obligations

      As of December 31, 2004, the Company’s outstanding contractual cash obligations were as follows (in thousands):

Item 7A. Quantitative and Qualitative Disclosures about Market Risk

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

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

      The Company targets its portfolio to have maturities of twenty-four months or less. Investments are held to enhance the preservation of capital and not for trading purposes.

      Interest rates. Cash equivalents consist of money market accounts with original maturities of less than three months. Short-term investments include obligations of U.S. government agencies and corporate debt securities with ratings of at least double–A by Moody’s or Standard and Poor, which limits credit risk.

      Interest on the Credit Facility, as amended, which expires on May 28, 2005, is based on Prime Rate plus 1.0% per annum (reduced to Prime Rate plus 0.5% per annum upon two consecutive quarters of net profitability, as defined). As of December 31, 2004, $4.5 million was available for borrowing under the Credit Facility with $0.4 million outstanding under the Equipment Term Note. As of December 31, 2004, total investments in marketable securities were $10.5 million. Changes in amounts borrowed or interest rates could impact the Company’s anticipated interest income from interest-bearing cash accounts, or cash equivalents, investments in marketable securities, as well as interest expense on borrowings under the Credit Facility.

Item 8. Financial Statements and Supplementary Data

INDEX

Report of Independent Registered Public Accounting Firm

The Board of Directors and Stockholders

The Ultimate Software Group, Inc.:

      We have audited the accompanying consolidated balance sheets of The Ultimate Software Group, Inc. and subsidiary (the “Company”) as of December 31, 2004 and 2003, and the related consolidated statements of operations, stockholders’ equity (deficit), and cash flows for each of the years in the three-year period ended December 31, 2004. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.

      We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

      In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of the Company as of December 31, 2004 and 2003, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2004, in conformity with U.S. generally accepted accounting principles.

      We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the effectiveness of the Company’s internal control over financial reporting as of December 31, 2004, based on criteria established in Internal Control – Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO), and our report dated March 10, 2005, expressed an unqualified opinion on management’s assessment of, and the effective operation of, internal control over financial reporting.

Miami, Florida

March 10, 2005

THE ULTIMATE SOFTWARE GROUP, INC. AND SUBSIDIARY

CONSOLIDATED BALANCE SHEETS

The accompanying Notes to Consolidated Financial Statements

are an integral part of these financial statements.

THE ULTIMATE SOFTWARE GROUP, INC. AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF OPERATIONS

The accompanying Notes to Consolidated Financial Statements

are an integral part of these financial statements.

THE ULTIMATE SOFTWARE GROUP, INC. AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY (DEFICIT)

(In thousands)

The accompanying Notes to Consolidated Financial Statements

are an integral part of these financial statements.

THE ULTIMATE SOFTWARE GROUP, INC. AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF CASH FLOWS

The accompanying Notes to Consolidated Financial Statements

are an integral part of these financial statements.

THE ULTIMATE SOFTWARE GROUP, INC. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

1. NATURE OF OPERATIONS

      The Ultimate Software Group, Inc. (“Ultimate Software” or the “Company”) designs, markets, implements and supports payroll and workforce management solutions, marketed primarily to middle-market organizations with 500 to 15,000 employees. The Company reaches its customer base and target market through its direct sales force and a network of national, regional and local strategic partners.

2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Basis of Consolidation

      The consolidated financial statements include the accounts of the Company and its subsidiary, Ultimate Benefits, Inc., an inactive company. Intercompany accounts and transactions have been eliminated in consolidation.

Cash and Cash Equivalents

      All highly liquid instruments with an original maturity of three months or less when acquired are considered cash equivalents and are comprised of interest-bearing accounts.

Accounts Receivable

      Accounts receivable are principally from end-users of the Company’s products. The Company performs credit evaluations of its customers and has recorded allowances for estimated losses. 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. 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.

Investments in Marketable Securities

      The Company classifies its investments in marketable securities with readily determinable fair values as securities available-for-sale in accordance with Statement of Financial Accounting Standards No. 115, “Accounting for Certain Investments in Debt and Equity Securities” (“FAS 115”). The Company has classified all investments as available-for-sale. Available-for-sale securities consist of debt and equity securities not classified as trading securities nor as securities to be held to maturity. Unrealized holding gains and losses on securities available-for-sale are reported as a net amount in accumulated other comprehensive loss in stockholders’ equity until realized. Gains and losses on the sale of securities available-for-sale are determined using the specific identification method.

      The amortized cost and market value of the Company’s investments in available-for-sale securities at December 31, 2004 are shown in the table below. There were no such investments held at December 31, 2003 or during the fiscal year then ended (in thousands).

      The amortized cost and estimated fair value of the available-for-sale securities by contractual maturity at December 31, 2004 are shown below (in thousands):