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

The Company's significant accounting policies discussed in Note 3 to its audited consolidated financial statements for the fiscal year ended December 31, 2007, included in the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 2007, filed with the Securities and Exchange Commission (the "SEC") on March 13, 2008 (the "2007 Form 10-K"), have not significantly changed, except as noted in Part I, Item 1, Note 3 above in the Company's Notes to Unaudited Condensed Financial Statements.

Executive Summary

Ultimate Software provides end-to-end strategic human resources, payroll, and talent management solutions primarily to middle-market organizations with 200 to 15,000 employees.

Ultimate Software's UltiPro software ("UltiPro") is a comprehensive Web-based solution designed to deliver the functionality businesses need to manage the employee life cycle, from recruiting and hiring to compensating and managing benefits to terminating, whether the customer's processes are centralized at headquarters or distributed across multiple divisions or branch offices. UltiPro's end-to-end functionality includes comprehensive online recruitment and onboarding tools, human resources ("HR") and benefits management, a strong payroll engine, time and attendance management, workforce scheduling, on-line benefits enrollment, training management, performance and learning management, reporting and analytical decision-making tools, and a self-service Web portal for executives, managers, administrators, and employees. Ultimate Software believes that UltiPro helps customers streamline HR and payroll processes to significantly reduce administrative and operational costs, while also empowering managers and staff to analyze workforce trends for better decision making, to access critical information quickly and to perform routine business activities efficiently.

Ultimate Software's software-as-a-service, branded "Intersourcing" (the "Intersourcing Offering"), provides Web access to comprehensive workforce management functionality for organizations that need to simplify the information technology ("IT") support requirements of their business applications. Intersourcing is available to companies primarily on a subscription basis (priced on a per employee per month, or "PEPM" basis) and is known in the industry as "software-as-a-service" ("SaaS") and on-demand. Ultimate Software believes that Intersourcing is attractive to companies that want to focus on their core competencies to increase sales and profits. Through the Intersourcing model, Ultimate Software provides the hardware, infrastructure, ongoing maintenance and backup services for its customers at two data centers, one located in the Miami, Florida area and the other in the Atlanta, Georgia area.

The Company's target market has primarily been middle-market organizations with 200 to 15,000 employees. The Company reaches its customer base and target market through its direct sales force. In late 2007, the Company began the expansion of its sales team to accommodate its new solution offering, branded "Workplace." Workplace is an offering of UltiPro, targeted for companies with 200 to 700 employees, and is a subscription-based SaaS solution that provides these medium-sized and smaller companies with nearly all the features that larger companies (which the Company refers to as "Enterprise" customers) have with UltiPro, plus a bundled service package. Workplace is designed to give these relatively smaller customers a high degree of convenience since Ultimate Software handles system setup, business rules, and other situations for customers "behind the scenes," and many companies of this size do not have IT staff on-premises to help with system issues. Since the introduction of Workplace in late 2007, the Company has continued to invest in this solution. The Company's sales force is segregated between sales associates who sell to Workplace customers (or the Workplace sales team) and sales associates who sell to the Company's Enterprise customers (or the Enterprise sales team).

During the second quarter of 2008, the Company rolled out two new product offerings directed at its Workplace market. Ultimate Software purchased the source code for a time and attendance solution from a third party during the second quarter of 2008. The Company has rebranded this product as UltiPro Time Management for Workplace customers. In addition, Ultimate Software introduced UltiPro Tax Filing for its Workplace market ("Tax Filing" offering). Workplace product offerings are sold only on a subscription basis.

The Company's main sources of revenues include sales from the Intersourcing Offering, sales of perpetual software licenses for UltiPro to customers who do not prefer a subscription-based arrangement (and the related annual maintenance) and sales of services (mostly implementation) related to both Intersourcing and license sales. Intersourcing revenues and maintenance revenues are the primary components of recurring revenues in the Company's condensed consolidated statements of operations.

Since the introduction of the Intersourcing Offering in 2002, the revenue mix in the Company's sales production has continued to favor Intersourcing. As Intersourcing units are sold, the recurring revenue backlog associated with Intersourcing grows, enhancing the predictability of future revenue streams. Intersourcing sales include a one-time upfront fee, priced on a per-employee basis, and ongoing monthly fees, priced on a PEPM basis. Revenue recognition for Intersourcing is triggered when the related customer processes its first live payroll (or goes "Live"). When an Intersourcing customer goes Live, the related upfront fees are recognized as recurring subscription revenues ratably over the term of the related contract (typically 24 months) and the Company begins recognizing the associated ongoing monthly PEPM fees.

In connection with the Company's business strategy, an internal financial metric used by the Company in measuring future financial performance is new annual recurring revenues ("ARR"). ARR represent the expected one-year value from (i) new Intersourcing sales from the Company's hosted model (including prorated one-time fees); (ii) maintenance revenues related to new software license sales; and (iii) recurring revenues from additional sales to Ultimate Software's existing customer base.

New ARR attributable to sales during the three months ended September 30, 2008 were $10.8 million as compared to $7.1 million for the same period in 2007. New ARR attributable to sales during the nine months ended September 30, 2008 were $29.3 million as compared to $20.1 million for the same period in 2007. The main contributors to the increase in new ARR were new sales of the Company's Intersourcing Offering, including sales of UltiPro (both Enterprise and Workplace) and complementary products (including prorated one-time fees).

Critical Accounting Estimates

The preparation of the Company's financial statements in conformity with generally accepted accounting principles in the United States ("GAAP") requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. The Company's critical accounting estimates, as discussed in Item 7, Management's Discussion and Analysis of Financial Condition and Results of Operations, included in the 2007 Form 10-K have not significantly changed through the date hereof.

Results of Operations

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

                                              For the Three Months             For the Nine Months
                                               Ended September 30,             Ended September 30,
                                              2008             2007           2008             2007
Revenues:
Recurring                                        60.9 %           58.6 %         60.4 %           57.4 %
Services                                         34.2             32.6           32.8             32.7
License                                           4.9              8.8            6.8              9.9
Total revenues                                  100.0            100.0          100.0            100.0
Cost of revenues:
Recurring                                        18.1             14.9           16.6             15.2
Services                                         29.0             26.6           26.9             26.9
License                                           1.1              0.9            1.1              0.9
Total cost of revenues                           48.2             42.4           44.6             43.0
Operating expenses:
Sales and marketing                              28.4             23.9           27.5             24.0
Research and development                         22.5             18.8           21.8             19.2
General and administrative                       10.7              9.6           10.4              9.5
Total operating expenses                         61.7             52.3           59.7             52.7
Operating income (loss)                          (9.8 )            5.3           (4.3 )            4.3
Other income (expense):
   Interest expense and other                    (0.1 )           (0.2 )         (0.1 )           (0.1 )
   Other income, net                              0.4              1.1            0.5              5.1
Total other income, net                           0.3              0.9            0.4              5.0
Income (loss) before income taxes                (9.5 )            6.2           (3.9 )            9.3
   Benefit (provision) for income taxes           2.6                -            1.2             (0.1 )
Net income (loss)                                (6.9 ) %          6.2 %         (2.7 ) %          9.2 %

Revenues

The Company's significant revenue recognition policies, as discussed in Note 3 to its 2007 Form 10-K, have not changed through the date hereof.

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

Recurring revenues consist of Intersourcing revenues, maintenance revenues and, to a lesser extent, subscription revenues. Intersourcing revenues are derived from the Intersourcing Offering which is a bundled offering that includes the right to use the Company's UltiPro product (and complementary products, where applicable), hosting services and the right to upgrades for such products as well as telephone support (which represents the maintenance component of the bundled offering). Both the Enterprise and Workplace sales teams contribute to Intersourcing sales production. Maintenance revenues (excluding the component embedded in the bundled Intersourcing Offering) are derived from license sales, representing the right to upgrades and telephone support. Subscription revenues are derived from PEPM fees generated by third party business service providers. License sales are generated by the Enterprise sales team only.

Services revenues include revenues from fees charged for the implementation of the Company's software products and training of customers in the use of such products, fees for other services, including the provision of payroll-related forms and the printing of Form W-2's for certain customers, as well as certain reimbursable out-of-pocket expenses.

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.

Total revenues, consisting of recurring, services and license revenues, increased 16.1% to $43.9 million for the three months ended September 30, 2008 from $37.8 million for the three months ended September 30, 2007, and 17.9% to $128.9 million for the nine months ended September 30, 2008 from $109.3 million for the nine months ended September 30, 2007.

Recurring revenues increased 20.6% to $26.7 million for the three months ended September 30, 2008 from $22.2 million for the three months ended September 30, 2007, and 24.1% to $77.8 million for the nine months ended September 30, 2008 from $62.7 million for the nine months ended September 30, 2007. The increases for the three and nine months ended September 30, 2008 were primarily due to increases in Intersourcing revenues and, to a lesser extent, maintenance revenues, partially offset by a decrease in subscription revenues, as described below:

a) Intersourcing revenues increased 46.3% and 50.9% for the three and nine months ended September 30, 2008, respectively, in comparison to the same periods of 2007, primarily due to the continued growth of the Intersourcing Offering, which comprised the majority of unit sales. The increase in Intersourcing revenues is based on the revenue impact of incremental units that have gone Live since September 30, 2007, including both UltiPro and, to a lesser extent, complementary products such as UltiPro Time and Attendance ("UTA") and UltiPro Recruitment. Intersourcing revenues from the Workplace solution in 2008 also contributed to the year-over-year growth, particularly since this solution was introduced after September 30, 2007. Recognition of recurring revenues for Intersourcing sales commences upon Live date. The Company's rolling twelve month retention rate of 97% for existing Intersourcing customers also contributed to the growth in Intersourcing revenues when combined with continued sales growth.

b) Maintenance revenues from license sales increased 8.6% and 10.7% for the three and nine months ended September 30, 2008, respectively, in comparison to the same periods of 2007, due to additional maintenance fees resulting from cumulative net increases in the customer base subsequent to September 30, 2007 due to incremental license sales since such date. Maintenance revenues are recognized over the initial term of the related license contract, which is typically 12 months, and then on a monthly recurring basis thereafter as the maintenance contracts renew annually. The Company's rolling twelve month retention rate of 97% for existing customers' annual maintenance renewals in the three and nine months ended September 30, 2008, combined with the annual price increases that typically accompany annual renewals, also contributed to the increase in maintenance revenues.

c) The impact on recurring revenues of units sold under the Intersourcing Offering (as compared to the typical immediate impact on license revenues of licensed units sold) has been and is expected to be a gradual increase from one period to the next, based on the incremental effect of revenue recognition of the Intersourcing fees over the terms of the related contracts as sales in backlog go Live.

d) Recurring subscription revenues decreased 70.1% and 54.3% for the three and nine months ended September 30, 2008, respectively, in comparison to the same periods of 2007, due to the termination of the Company's agreement with Ceridian Corporation effective March 9, 2008, at which time the related revenue recognition ended.

Services revenues increased 21.8% to $15.0 million for the three months ended September 30, 2008 from $12.3 million for the three months ended September 30, 2007, and 18.2% to $42.3 million for the nine months ended September 30, 2008 from $35.8 million for the nine months ended September 30, 2007. The increases for the three and nine months ended September 30, 2008 were mainly due to an increase in implementation revenues principally attributable to additional billable hours, implementation revenues recognized for the new Workplace sales, and, to a lesser extent, an increase in the blended net rate per hour. The additional billable hours stemmed from additional hours worked by more revenue-generating consultants than in the prior year comparable period (as the Company hired more implementation personnel to accommodate the increased sales growth) as well as additional hours worked by third-party implementation partners ("IP's").

License revenues decreased 34.9% to $2.2 million for the three months ended September 30, 2008 from $3.3 million for the three months ended September 30, 2007. For the nine months ended September 30, 2008, license revenues decreased 18.9% to $8.8 million from $10.8 million for the nine months ended September 30, 2007. The decreases in both the three and nine month periods ended September 30, 2008 were principally due to a reduced number of new license units sold as more customers chose the Company's subscription-based Intersourcing Offering.

Cost of Revenues

Cost of revenues consists of the cost of recurring, services and license revenues. Cost of recurring revenues consists of costs to provide maintenance and technical support to the Company's customers, the cost of providing periodic updates and the cost of subscription revenues, including amortization of capitalized software. Cost of services revenues primarily consists of costs to provide implementation services and training to the Company's customers and, to a lesser degree, costs related to sales of payroll-related forms and costs associated with certain reimbursable out-of-pocket expenses, discussed below. Cost of license revenues primarily consists of fees payable to third parties for software products distributed by the Company. UltiPro includes third-party software for enhanced report writing purposes and for time and attendance functionality. The Company pays a distribution license fee to a third-party provider for report writing software used in conjunction with UltiPro. When UltiPro licenses are sold with this software or the add-on UTA product, customers pay the Company on a per user basis for the license rights to such third-party software.

Total cost of revenues (including $0.7 million and $2.3 million in stock-based compensation expense for the three and nine months ended September 30, 2008, respectively, as compared to $0.5 million and $1.7 million for the three and nine months ended September 30, 2007, respectively) increased 31.7% to $21.1 million for the three months ended September 30, 2008 from $16.0 million for the three months ended September 30, 2007, and 22.0% to $57.4 million for the nine months ended September 30, 2008 from $47.1 million for the nine months ended September 30, 2007.

Cost of recurring revenues increased 40.8% to $7.9 million for the three months ended September 30, 2008 from $5.6 million for the three months ended September 30, 2007 and 29.2% to $21.5 million for the nine months ended September 30, 2008 from $16.6 million for the nine months ended September 30, 2007. The $2.3 million and $4.9 million increases in cost of recurring revenues for the three and nine months ended September 30, 2008, respectively (which included stock-based compensation expense of $0.2 million and $0.7 million for the three and nine months ended September 30, 2008, respectively, as compared to $0.2 million and $0.5 million for the three and nine months ended September 30, 2007, respectively), were primarily due to the increases in both Intersourcing costs and maintenance costs. The increase in Intersourcing costs was principally due to the growth in Intersourcing operations and increased sales, including increased labor costs and higher operating costs such as increased third-party royalty fees for UTA sales, depreciation and amortization of related computer equipment supporting the hosting operations and increased hosting data center costs. In addition, there was increased amortization for UltiPro Canadian HR/payroll ("UltiPro Canada") due to the general release of UltiPro Canada in the fourth quarter of 2007 and the resulting commencement of the amortization of the capitalized costs. The increase in maintenance costs was primarily related to increased labor costs commensurate with the growth in the number of customers in the Company's base.

Cost of services revenues increased 26.7% to $12.8 million for the three months ended September 30, 2008 from $10.1 million for the three months ended September 30, 2007, and 17.6% to $34.6 million for the nine months ended September 30, 2008 from $29.4 million for the nine months ended September 30, 2007. The increase in cost of services revenues for the three-month period ended September 30, 2008 (which included stock-based compensation expense of $0.5 million for the three months ended September 30, 2008, as compared to $0.3 million for the three months ended September 30, 2007) was primarily due to an increase in costs of implementation. The implementation cost increase for the three-month period was mainly attributable to labor costs associated with growing the implementation infrastructure (predominantly billable consultants) to accommodate the overall growth in unit sales and, to a lesser extent, increased costs for third-party IP's which correlate with the increased implementation revenues generated from the work performed by IP's. The increase in cost of services revenues for the nine month period ended September 30, 2008 (which included stock-based compensation expense of $1.6 million for the nine months ended September 30, 2008, as compared to $1.2 million for the nine months ended September 30, 2007), was primarily due to an increase in costs of implementation and, to a lesser extent, an increase in training costs. The increases in implementation costs and training costs were primarily labor costs associated with the growth in the Intersourcing operations (including the growth in Enterprise and Workplace unit sales).

Cost of license revenues increased 31.5% to $463 thousand for the three months ended September 30, 2008 from $352 thousand for the three months ended September 30, 2007, and increased 32.1% to $1.4 million for the nine months ended September 30, 2008 from $1.0 million for the nine months ended September 30, 2007. The increases in cost of license revenues for the three and nine months ended September 30, 2008 as compared to the same periods in 2007 were primarily due to increased third-party royalty fees tied to increased sales of UTA products, and increased amortization for capitalized software resulting from the general release of UltiPro Canada in the fourth quarter of 2007 and the commencement of the related amortization.

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 38.1% to $12.5 million for the three months ended September 30, 2008 from $9.0 million for the three months ended September 30, 2007 and 35.3% to $35.5 million for the nine months ended September 30, 2008 from $26.3 million for the nine months ended September 30, 2007. The increases in sales and marketing expenses for the three and nine month periods ended September 30, 2008 (including $2.0 million and $5.7 million, respectively, of stock-based compensation expense as compared to $1.2 million and $3.3 million of stock-based compensation expense for the three and nine months ended September 30, 2007, respectively) were primarily due to increased labor and related costs attributable to hiring additional direct sales force personnel (particularly for the Company's Workplace solution) and higher sales commissions principally related to increased Intersourcing sales. Marketing expenses associated with the investment in the Workplace solution also increased from the same periods in the prior year. Commissions on license sales are recognized when the license revenues are recognized, which is typically when the product is shipped. Commissions on Intersourcing sales are amortized over the initial contract term (typically 24 months) commencing on the Live date, which corresponds to the Intersourcing revenue recognition.

Research and Development

Research and development expenses consist primarily of software development personnel costs. Research and development expenses increased 39.5% to $9.9 million for the three months ended September 30, 2008 from $7.1 million for the three months ended September 30, 2007, and 34.1% to $28.1 million for the nine months ended September 30, 2008 from $20.9 million for the nine months ended September 30, 2007. The increases in research and development expenses for the three and nine month periods ended September 30, 2008 (including $0.3 million and $1.3 million, respectively, of stock-based compensation expense as compared to $0.2 million and $0.8 million for the three and nine months ended September 30, 2007, respectively) were principally due to higher labor costs related to the ongoing development of UltiPro and complementary products, including the impact of increased staffing costs (from additional headcount) and increased third-party consulting costs, and, to a lesser extent, a net reduction in capitalized labor costs. Capitalization of costs for UltiPro Canada ended in November 2007 (upon its general release) and certain labor costs were capitalized in the three and nine months ended September 30, 2008 in relation to a new product offering referred to as Onboarding which is a product that handles certain human resources functionality for new hires of a company, and has an expected general release toward the end of 2008 upon its full integration with UltiPro.

General and Administrative

General and administrative expenses consist primarily of salaries and benefits of executive, administrative and financial personnel, as well as external professional fees and the provision for doubtful accounts. General and administrative expenses for the three months ended September 30, 2008 increased 28.9% to $4.7 million from $3.6 million for the three months ended September 30, 2007 and 29.5% to $13.4 million for the nine months ended September 30, 2008 from $10.3 million for the nine months ended September 30, 2007. The increases for the three and nine months ended September 30, 2008 (including $0.9 million and $2.8 million of stock-based compensation expense, respectively, and $46 thousand and $0.1 million, of amortization of acquired intangible assets, respectively, as compared to $0.7 million and $1.5 million of stock-based compensation expense and $0.1 million and $0.2 million of amortization of acquired intangible assets for the three and nine months ended September 30, 2007, respectively) were primarily due to additional labor and related costs (including additional personnel costs to support the Company's growth) and, to a lesser extent, an increase in the provision for doubtful accounts.

Interest Expense and Other

Interest expense and other of $33 thousand and $173 thousand for the three and nine months ended September 30, 2008, respectively, was comparable to interest expense and other during the same period in the prior year ($61 thousand and $161 thousand for the three and nine months ended September 30, 2007, respectively).

Other Income, Net

Other income, net, decreased to $168 thousand for the three months ended September 30, 2008 from $433 thousand for the three months ended September 30, 2007 and to $747 thousand for the nine months ended September 30, 2008 from $5.6 . . .