The following discussion of the financial condition and results of operations of The Ultimate Software Group, Inc. and its subsidiaries ("Ultimate" 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 (the "Form 10-Q") and in the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 2008, filed with the Securities and Exchange Commission (the "SEC") on March 2, 2009 (the "Form 10-K").

The Company's significant accounting policies discussed in Note 3 to its audited consolidated financial statements for the fiscal year ended December 31, 2008, included in the Form 10-K have not significantly changed.

Executive Summary

Ultimate designs, markets, implements and supports human resources ("HR"), payroll and talent management solutions principally in the United States and Canada.

Ultimate's UltiPro software ("UltiPro" or "Core UltiPro") is a comprehensive Internet-based solution designed to deliver the functionality businesses need to manage the complete employment life cycle from recruitment to retirement.

Ultimate's software-as-a-service ("SaaS") offering, branded "Intersourcing" (the "Intersourcing Offering"), provides on-line access to comprehensive human capital management functionality for organizations that need to simplify the information technology ("IT") support requirements of their business applications. Through the Intersourcing Offering, Ultimate provides the hardware, infrastructure, ongoing maintenance and backup services for its customers at two data centers located in the Miami, Florida and Atlanta, Georgia areas. Both data centers are owned and operated by a third party, Quality Technology Services ("QTS"). QTS is one of the largest privately-held providers of data center facilities and management services in the United States. During the three months ended September 30, 2009, Ultimate opened a third data center in Toronto, Canada, which is owned and operated by Verizon Communications Inc. This new data center is for the Company's customers with employees exclusively based in Canada.

UltiPro is available as two solution suites, based on company size. UltiPro Enterprise ("Enterprise") was developed to address the needs of large and very large companies (700 or more employees and including companies as large as 15,000 employees and larger) and is delivered as either a SaaS solution or an on-premise solution. UltiPro Workplace ("Workplace") was developed for companies in the mid-market (200 to 700 employees) and is delivered exclusively as SaaS. UltiPro Workplace provides medium-sized and smaller companies with nearly all the features that larger Enterprise companies have with UltiPro, plus a bundled service package. Since many companies in this market do not have IT staff on their premises to help with system issues, UltiPro Workplace is designed to give these customers a high degree of convenience by handling system setup, business rules, and other situations for customers "behind the scenes." UltiPro is marketed primarily through the Company's Enterprise and Workplace direct sales teams.

In addition to Core UltiPro's HR/payroll functionality, the Company's customers have the option to purchase a number of additional features on a per-employee-per-month (or "PEPM") basis, which are available to enhance the functionality of UltiPro's core features based on certain business needs of the customers. These optional UltiPro features currently include (i) the talent management suite of products; (ii) benefits enrollment; (iii) time, attendance and scheduling; (iv) time management; (v) tax filing; (vi) wage attachments; and
(vii) other optional features (collectively, "Optional Features"). All Optional Features are individually priced solely on a subscription basis with some of the Optional Features available to both Enterprise and Workplace customers while others are available exclusively to either Enterprise or Workplace customers, based on the needs of the respective customers, including their employee size and the complexity of their HR/payroll environment.

Ultimate has two primary revenue sources: recurring revenues and services revenues. Intersourcing subscription revenues and maintenance revenues are the primary components of the Company's recurring revenues. Ultimate's annualized retention rate for its existing recurring revenue customer base was 97% as of September 30, 2009. The majority of services revenues are derived from implementation services and, to a lesser extent, training services. In addition to recurring revenues and services revenues, until April 1, 2009 Ultimate marketed on-site UltiPro solutions on a perpetual license basis, through which it has recognized license revenues. For the three and nine months ended September 30, 2009, license revenues, as a percentage of total revenues, represented 0.5% and 2.4%, respectively, as compared to 4.9% and 6.8% for the three and nine months ended September 30, 2008, respectively.

On February 5, 2009, Ultimate announced that after April 1, 2009 it no longer intended to sell its on-site UltiPro solutions on a perpetual license basis. However, the Company continues to sell on-premise UltiPro solutions on a subscription basis (priced and billed to customers on a PEPM basis). Since April 1, 2009, the Company has had license revenues attributable to contractual arrangements with existing license customers which primarily relate to growth provisions for the underlying employee base and/or the contractual rights of existing license customers to purchase Optional Features of UltiPro. After the elimination of sales of perpetual licenses to new customers, the variable costs associated with new customer licenses, such as related sales commissions, are also eliminated. As a result of the discontinued sales of perpetual licenses to new customers, certain fixed third-party costs that were formerly allocated to costs of license revenues (in proportion to their contribution to the total sales mix) were shifted to costs of recurring revenues. When perpetual license agreements were sold, annual maintenance contracts (priced as a percentage of the related license fee) accompanied those agreements. Maintenance contracts typically have a one-year term with annual renewal periods thereafter. The Company has historically maintained a strong customer retention rate for its renewal maintenance agreements and does not foresee its decision to discontinue sales of perpetual license agreements to new customers to materially affect its future maintenance revenues (as they relate to existing license customers).

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 (or setup) 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 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 as recurring subscription revenues.

Critical Accounting Estimates

The preparation of the Company's financial statements in conformity with U.S. generally accepted accounting principles ("GAAP") requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. 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 Form 10-K, have not significantly changed.

Results of Operations

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

                                    For the Three Months            For the Nine Months
                                     Ended September 30,            Ended September 30,
                                     2009            2008           2009            2008
  Revenues:
  Recurring                             70.9 %         60.9 %          67.7 %         60.4 %
  Services                              28.6           34.2            29.9           32.8
  License                                0.5            4.9             2.4            6.8
  Total revenues                       100.0          100.0           100.0          100.0
  Cost of revenues:
  Recurring                             20.7           18.1            19.7           16.6
  Services                              24.1           29.0            24.3           26.9
  License                                0.0            1.1             0.4            1.1
  Total cost of revenues                44.8           48.2            44.4           44.6
  Operating expenses:
  Sales and marketing                   27.1           28.4            27.6           27.5
  Research and development              20.6           22.5            20.0           21.8
  General and administrative             9.0           10.7             9.2           10.4
  Total operating expenses              56.7           61.7            56.8           59.7
  Operating loss                        (1.4 )         (9.8 )          (1.1 )         (4.3 )
  Other income (expense):
     Interest expense and other         (0.1 )         (0.1 )          (0.1 )         (0.1 )
     Other income, net                   0.1            0.4             0.1            0.5
  Total other income, net                0.0            0.3             0.0            0.4
  Loss before income taxes              (1.4 )         (9.5 )          (1.1 )         (3.9 )
     Benefit for income taxes            0.5            2.6             0.3            1.2
  Net loss                              (0.9 ) %       (6.9 ) %        (0.8 ) %       (2.7 ) %

The following table sets forth the non-cash stock-based compensation expense (excluding the income tax effect) resulting from the stock-based arrangements and the amortization of acquired intangibles that are recorded in the Company's unaudited condensed consolidated statements of operations for the periods indicated (in thousands):

                                              For the Three Months            For the Nine Months
                                               Ended September 30,            Ended September 30,
                                              2009             2008           2009           2008
Stock-based compensation:
  Cost of recurring revenues                       170             191            506            689
  Cost of services revenues                        326             479            994          1,565
  Cost of license revenues                           -               2              -              9
  Sales and marketing                            1,776           2,043          5,311          5,656
  Research and development                         316             316            926          1,257
  General and administrative                       735             924          2,175          2,793
 Total non-cash stock-based compensation
expense                                    $     3,323       $   3,955     $    9,912      $  11,969

Amortization of acquired intangibles:
General and administrative
                                           $        55       $      46     $      147      $     139

Revenues

The Company's revenues are derived from recurring revenues and services revenues and, to a lesser extent, license revenues. The Company's significant revenue recognition policies, as discussed in Note 3 to its audited consolidated financial statements for the fiscal year ended December 31, 2008, included in the Form 10-K, have not changed.

Total revenues, consisting of recurring, services and license revenues, increased 9.8% to $48.2 million for the three months ended September 30, 2009 from $43.9 million for the three months ended September 30, 2008, and 12.0% to $144.3 million for the nine months ended September 30, 2009 from $128.9 million for the nine months ended September 30, 2008.

Recurring revenues increased 27.7 % to $34.2 million for the three months ended September 30, 2009 from $26.7 million for the three months ended September 30, 2008, and 25.5% to $97.7 million for the nine months ended September 30, 2009 from $77.8 million for the nine months ended September 30, 2008. The increases for the three and nine months ended September 30, 2009 were primarily due to increases in Intersourcing revenues and, to a lesser extent, maintenance revenues (discussed below).

a) Intersourcing revenues increased 41.8% and 41.0% for the three and nine months ended September 30, 2009, respectively, in comparison to the same periods in 2008. The increases in Intersourcing revenues were based on the revenue impact of incremental units sold that have gone Live since September 30, 2008, including Core UltiPro and, to a lesser extent, Optional Features of UltiPro. Intersourcing revenues from the Workplace solution in 2009 also contributed to the year-over-year growth, particularly since this solution was introduced late in 2007 and was ramping up in 2008. Recognition of recurring subscription revenues for Intersourcing sales begins when the related customer goes Live.

b) Maintenance revenues from past license sales increased 1.7% and 2.5% for the three and nine months ended September 30, 2009, in comparison to the same periods of 2008, due to additional maintenance fees resulting from cumulative net increases in the customer base subsequent to September 30, 2008 resulting from 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.

Services revenues decreased 8.1% to $13.8 million for the three months ended September 30, 2009 from $15.0 million for the three months ended September 30, 2008, and increased 2.0% to $43.1 million for the nine months ended September 30, 2009 from $42.3 million for the nine months ended September 30, 2008. The decrease for the three months ended September 30, 2009 was mainly due to (i) less billable hours from the reduced use of third party implementation partners ("IP's") and, to a lesser extent, from fewer Ultimate revenue-generating consultants for Enterprise sales, and, to a lesser extent, (ii) a decrease in the Enterprise blended net rate per hour, partially offset by (iii) higher implementation revenues recognized for Workplace sales principally resulting from incremental Workplace sales production. The increase for the nine months ended September 30, 2009 was primarily related to (i) higher implementation revenues recognized for Workplace sales and, to a lesser extent, (ii) an increase in the blended net rate per hour for Enterprise implementations, partially offset by (iii) less billable hours from IP's.

License revenues decreased 88.4% to $0.3 million for the three months ended September 30, 2009 from $2.2 million for the three months ended September 30, 2008. For the nine months ended September 30, 2009, license revenues decreased 59.8% to $3.5 million from $8.8 million for the nine months ended September 30, 2008. The decreases in the three and nine month periods ended September 30, 2009 were principally due to the Company's decision not to sell perpetual licenses to new customers after April 1, 2009.

Cost of Revenues

Cost of revenues primarily consists of the costs of recurring and services revenues. Cost of recurring revenues primarily consists of costs to provide maintenance and technical support to the Company's customers, the cost of providing periodic updates and the cost of recurring 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 client reimbursable out-of-pocket expenses.

Total cost of revenues increased 1.9% to $21.6 million for the three months ended September 30, 2009 from $21.1 million for the three months ended September 30, 2008, and 11.5% to $64.1 million for the nine months ended September 30, 2009 from $57.4 million for the nine months ended September 30, 2008.

Cost of recurring revenues increased 25.6% to $10.0 million for the three months ended September 30, 2009 from $7.9 million for the three months ended September 30, 2008 and 32.5% to $28.4 million for the nine months ended September 30, 2009 from $21.5 million for the nine months ended September 30, 2008. The $2.1 million and $6.9 million increases in cost of recurring revenues for the three and nine months ended September 30, 2009, respectively, were primarily due to increases in both Intersourcing costs and maintenance costs. Intersourcing costs increased principally as a result of the growth in Intersourcing operations and increased sales, including higher depreciation and amortization of related computer equipment supporting the hosting operations, increased hosting data center costs and, to a lesser extent, increased labor costs, amortization of capitalized software and increased third-party royalty fees for UltiPro time, attendance and scheduling sales. Maintenance costs increased primarily due to higher labor costs commensurate with the growth in the Company's recurring revenues customer base.

Cost of services revenues decreased 9.1% to $11.6 million for the three months ended September 30, 2009 from $12.8 million for the three months ended September 30, 2008, and increased 1.2% to $35.0 million for the nine months ended September 30, 2009 from $34.6 million for the nine months ended September 30, 2008. Cost of services revenues decreased for the three months ended September 30, 2009 primarily due to lower IP costs and lower labor and related costs (including fewer billable Enterprise consultants, partially offset by higher Workplace implementation labor costs). Cost of services revenues increased for the nine months ended September 30, 2009 principally due to an increase in costs of implementation, mainly attributable to labor costs associated with building the Workplace implementation infrastructure, partially offset by decreased costs of IP's.

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 4.5% to $13.0 million for the three months ended September 30, 2009 from $12.5 million for the three months ended September 30, 2008, and 11.9% to $39.8 million for the nine months ended September 30, 2009 from $35.5 million for the nine months ended September 30, 2008. Sales and marketing expenses increased for the three and nine month periods ended September 30, 2009 primarily due to increased labor and related costs attributable to hiring additional personnel for the Workplace direct sales team and higher sales commissions principally related to increased recurring subscription revenues from Intersourcing for both Enterprise and Workplace. Commissions on Intersourcing sales are amortized over the initial contract term (typically 24 months) commencing on the Live date, which corresponds to the revenue recognition for Intersourcing sales.

Research and Development

Research and development expenses consist primarily of software development personnel costs. Research and development expenses increased 0.3% to $9.9 million for the three months ended September 30, 2009 from $9.9 million for the three months ended September 30, 2008, and 2.7% to $28.9 million for the nine months ended September 30, 2009 from $28.1 million for the nine months ended September 30, 2008 principally due to higher labor costs related to the ongoing development of Core UltiPro and Optional Features, partially offset by lower third-party consulting costs.

General and Administrative

General and administrative expenses consist primarily of salaries and benefits of executive, administrative and financial personnel, as well as external professional fees and the provision for doubtful accounts. General and administrative expenses decreased 7.4% to $4.4 million for the three months ended September 30, 2009 from $4.7 million for the three months ended September 30, 2008. General and administrative expenses decreased 1.2% to $13.2 million for the nine months ended September 30, 2009 from $13.4 million for the nine months ended September 30, 2008. The decreases for the three and nine months ended September 30, 2009 were primarily due to lower labor-related costs and a decrease in the provision for doubtful accounts.

Income taxes for each of the three and nine months ended September 30, 2009 included a benefit of $0.2 million and $0.4 million, respectively. Income taxes for the three and nine months ended September 30, 2008 included a benefit of $1.1 million and $1.5 million, respectively. Net operating loss carryforwards available at December 31, 2008, expiring at various times from 2011 through 2028 and which are available to offset future taxable income, approximated $75.6 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.

Liquidity and Capital Resources

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

As of September 30, 2009, the Company had $30.7 million in cash, cash equivalents and total investments in marketable securities, reflecting a net increase of $7.7 million since December 31, 2008.
This $7.7 million increase was primarily due to cash provided by operations of $16.2 million, partially offset by cash purchases of property and equipment (including principal payments on financed purchases) of $5.3 million, repurchases of Common Stock (net of proceeds from the issuance of Common Stock from employee stock option exercises) of $2.6 million and payments related to capitalized software of $0.6 million.

Net cash provided by operating activities was $16.2 million for the nine months ended September 30, 2009 as compared to $18.5 million for the nine months ended September 30, 2008. This $2.3 million decrease was primarily due to additional vendor payments made (resulting in decreases in accounts payable and accrued expenses) and a decrease from accounts receivable (net of deferred revenue).

Net cash used in investing activities was $11.1 million for the nine months ended September 30, 2009 as compared to $3.5 million for the nine months ended September 30, 2008. The increase of $7.6 million from the comparable period in 2008 was primarily attributable to a decrease in cash provided from the maturities of marketable securities (net of purchases) of $11.8 million and an increase in funds received from and held on behalf of Ultimate's customers using the UltiPro tax filing offering ("UltiPro Tax Filing Customer Funds"), with such funds being invested by the Company in overnight repurchase agreements backed by U.S. Treasury or U.S. Government Agency securities of $3.6 million, partially offset by a decrease in cash purchases of property and equipment of $7.0 million (including the impact of increased equipment financing) and a $0.9 million decrease in capitalized software.

Net cash provided by financing activities was $0.6 million for the nine months ended September 30, 2009 as compared to net cash used in financing activities of $17.2 million for the nine months ended September 30, 2008. The $17.8 million increase in net cash provided by financing activities was primarily related to a $14.5 million decrease in repurchases of Common Stock pursuant to the Company's stock repurchase plan, an increase of $3.6 million in UltiPro Tax Filing Customer Funds received, partially offset by a $0.3 million decrease in proceeds from the issuance of Common Stock from stock option exercises.

Days sales outstanding, calculated on a trailing three-month basis, as of September 30, 2009 and September 30, 2008, were 67 days and 68 days, respectively.

Deferred revenues were $64.4 million at September 30, 2009, as compared to $63.5 million at December 31, 2008. The increase of $0.9 million in deferred revenues for the 2009 period was primarily due to increased deferred Intersourcing revenues and higher deferred services revenues, partially offset by decreased deferred maintenance revenues. Substantially all of the total balance in deferred revenues is related to future recurring revenues, including deferred revenues related to Intersourcing.

The Company believes that cash and cash equivalents, investments in marketable securities, equipment financing 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.

The Company did not have any material commitments for capital expenditures as of September 30, 2009.

Off-Balance Sheet Arrangements

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

Quarterly Fluctuations

The Company's quarterly revenues and operating results have varied significantly in the past and are likely to vary substantially from quarter to quarter in the future. The Company's operating results may fluctuate as a result of a number of factors, including, but not limited to, increased expenses (especially as they relate to product development, sales and marketing and the use of third-party consultants), timing of product releases, increased competition, variations in the mix of revenues, announcements of new products by 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 achieve and, if achieved in future periods, maintain profitability on a quarterly basis. The Company believes that, due to the underlying factors for quarterly fluctuations, quarter-to-quarter comparisons of its operations are not . . .