UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q/A
AMENDMENT NO. 1
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF
THE SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED MARCH 31, 2003
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from _______ to _______
Commission file number: 0-24347
THE ULTIMATE SOFTWARE GROUP, INC.
------------------------------------------------------
(Exact name of Registrant as specified in its charter)
Delaware 65-0694077
-------- ----------
State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization
2000 Ultimate Way, Weston, FL 33326
----------------------------- -----
(Address of principal executive offices) (Zip Code)
(954) 331 - 7000
----------------
(Registrant's telephone number, including area code)
None
----
(Former name, former address and former fiscal year, if changed
since last report)
Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark whether the Company is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act). Yes [ ] No [X]
As of May 1, 2003 there were 17,332,768 shares of the Registrant's
Common Stock, par value $.01, outstanding.
EXPLANATORY NOTE
The Ultimate Software Group, Inc. is filing this amendment to its
Quarterly Report on Form 10-Q for the period ended March 31, 2003, originally
filed on May 14, 2003, in response to comments received from the Securities and
Exchange Commission in connection with their review of the Registration
Statement on Form S-3 (File No. 333-107527) filed by The Ultimate Software
Group, Inc. on July 31, 2003. This Amendment No. 1 on Form 10-Q/A includes the
text of the Form 10-Q in its entirety and is being filed to:
(1) provide additional disclosure regarding critical accounting
policies in "Management's Discussion and Analysis of Financial Condition and
Results of Operations -- Critical Accounting Policies and Estimates,"
(2) provide additional disclosure regarding the services provided
under the Ceridian Services Agreement and the term of the Original Ceridian
Agreement in "Management's Discussion and Analysis of Financial Condition and
Results of Operations -- Overview,"
(3) provide greater detail concerning the reduction in the number
of license units sold and third-party licensed software in "Management's
Discussion and Analysis of Financial Condition and Results of Operations --
Results of Operations,"
(4) provide the disclosure required by Item 701 of Regulation S-K
of the Securities Act of 1933 in Part II, "Changes in Securities and Use of
Proceeds" and
(5) update the certifications of the chief executive and financial
officers in light of intervening Securities and Exchange Commission rules.
This filing amends the items specified above and does not otherwise
update the disclosures in the Form 10-Q as originally filed and does not reflect
events occurring after the original filing of the Form 10-Q.
In addition, The Ultimate Software Group, Inc. has filed the following
exhibits herewith:
31.1 Certification Pursuant to Rule 13a-14(a) and Rule 15d-14(a) of
the Securities Exchange Act of 1934, as amended
31.2 Certification Pursuant to Rule 13a-14(a) and Rule 15d-14(a) of
the Securities Exchange Act of 1934, as amended
32.1 Certification Pursuant to 18 U.S.C Section 1350, as adopted
pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
32.2 Certification Pursuant to 18 U.S.C Section 1350, as adopted
pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
THE ULTIMATE SOFTWARE GROUP, INC. AND SUBSIDIARY
TABLE OF CONTENTS
Page(s)
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PART I - FINANCIAL INFORMATION:
Item 1 - Financial Statements (unaudited): 1
Condensed Consolidated Balance Sheets as of March 31, 2003 and
December 31, 2002
Condensed Consolidated Statements of Operations for the Three Months
Ended March 31, 2003 and 2002
Condensed Consolidated Statements of Cash Flows for the Three Months
Ended March 31, 2003 and 2002
Notes to Condensed Consolidated Financial Statements 4
Item 2 - Management's Discussion and Analysis of Financial
Condition and Results of Operations 8
Item 3 - Quantitative and Qualitative Disclosures About Market Risk 20
Item 4 - Controls and Procedures 20
PART II - OTHER INFORMATION:
Item 2 - Changes in Securities and Use of Proceeds 20
Item 6 - Exhibits and Reports on Form 8-K 21
SIGNATURES 22
CERTIFICATIONS 23
PART 1--FINANCIAL INFORMATION
ITEM 1--FINANCIAL STATEMENTS
THE ULTIMATE SOFTWARE GROUP, INC. AND SUBSIDIARY
CONDENSED CONSOLIDATED BALANCE SHEETS
(Dollars in thousands, except share data)
As of As of
March 31, December 31,
2003 2002
----------- ------------
(Unaudited)
ASSETS
Current assets:
Cash and cash equivalents $ 8,394 $ 8,974
Accounts receivable, net 7,794 10,381
Prepaid expenses and other current assets 1,634 1,273
-------- --------
Total current assets 17,822 20,628
Property and equipment, net 6,917 7,233
Capitalized software, net 2,372 2,753
Other assets 542 529
-------- --------
Total assets $ 27,653 $ 31,143
======== ========
LIABILITIES AND STOCKHOLDERS' DEFICIT
Current liabilities:
Accounts payable $ 2,350 $ 2,693
Accrued expenses 4,893 5,529
Current portion of deferred revenue 20,145 20,874
Current portion of capital lease obligations 637 767
Current portion of long term debt 497 501
-------- --------
Total current liabilities 28,522 30,364
Deferred revenue, net of current portion 4,954 6,941
Capital lease obligations, net of current portion 225 361
Long term debt, net of current portion 720 845
-------- --------
Total liabilities 34,421 38,511
-------- --------
Stockholders' deficit:
Preferred Stock, $.01 par value, 2,000,000 shares authorized,
no shares issued or outstanding in 2003 and 2002 -- --
Series A Junior Participating Preferred Stock, $.01 par value,
500,000 shares authorized, no shares issued or outstanding
in 2003 and 2002, respectively -- --
Common Stock, $.01 par value, 50,000,000 shares authorized,
17,590,415 and 15,869,043 shares issued in 2003
and 2002, respectively 176 168
Additional paid-in capital 71,830 68,602
Accumulated deficit (77,720) (75,084)
-------- --------
(5,714) (6,314)
Treasury stock, at cost, 257,647 and 240,447 shares in 2003
and 2002, respectively (1,054) (1,054)
-------- --------
Total stockholders' deficit (6,768) (7,368)
-------- --------
Total liabilities and stockholders' deficit $ 27,653 $ 31,143
======== ========
The accompanying unaudited notes to condensed consolidated financial statements
are an integral part of these financial statements.
1
THE ULTIMATE SOFTWARE GROUP, INC. AND SUBSIDIARY
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share amounts)
For the Three Months
Ended March 31,
-----------------------------
2003 2002
-------- --------
Revenues, net:
License $ 1,213 $ 1,395
Recurring 6,861 3,934
Services 6,328 5,627
-------- --------
Total revenues, net 14,402 10,956
-------- --------
Cost of revenues:
License 243 140
Recurring 2,291 1,950
Services 4,435 4,558
-------- --------
Total cost of revenues 6,969 6,648
-------- --------
Operating expenses:
Sales and marketing 4,089 4,538
Research and development 4,329 4,331
General and administrative 1,618 1,130
-------- --------
Total operating expenses 10,036 9,999
-------- --------
Operating loss (2,603) (5,691)
Interest expense (53) (72)
Interest and other income 20 40
-------- --------
Net loss $ (2,636) $ (5,723)
======== ========
Net loss per share -- basic and diluted $ (0.16) $ (0.36)
======== ========
Weighted average shares outstanding:
Basic and diluted 16,718 15,885
======== ========
The accompanying unaudited notes to condensed consolidated financial statements
are an integral part of these financial statements.
2
THE ULTIMATE SOFTWARE GROUP, INC. AND SUBSIDIARY
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
For the Three Months
Ended March 31,
---------------------------
2003 2002
-------- --------
Cash flows from operating activities:
Net loss $ (2,636) $ (5,723)
Adjustments to reconcile net loss to net cash
(used in) provided by operating activities:
Depreciation and amortization 1,300 1,439
Provision for doubtful accounts 161 32
Non-cash issuance of stock options for board fees 31 21
Changes in operating assets and liabilities:
Accounts receivable 2,426 4,253
Prepaid expenses and other current assets (361) (98)
Other assets (13) (3)
Accounts payable (343) 263
Accrued expenses (636) (1,112)
Deferred revenue (2,716) 5,365
-------- --------
Net cash (used in) provided by operating activities (2,787) 4,437
-------- --------
Cash flows from investing activities:
Purchases of property and equipment (605) (623)
-------- --------
Net cash used in investing activities (605) (623)
-------- --------
Cash flows from financing activities:
Repurchase of treasury stock -- (119)
Principal payments on capital lease obligations (266) (579)
Principal payments on borrowings under Credit Facility (129) --
Net proceeds from issuances of Common Stock 3,207 9
-------- --------
Net cash provided by (used in) financing activities 2,812 (689)
-------- --------
Net (decrease) increase in cash and cash equivalents (580) 3,125
Cash and cash equivalents, beginning of period 8,974 8,464
-------- --------
Cash and cash equivalents, end of period $ 8,394 $ 11,589
======== ========
Supplemental disclosure of cash flow information:
Cash paid for interest $ 43 $ 60
======== ========
Supplemental disclosure of non-cash financing activities:
- The Company entered into capital lease obligations to acquire new equipment
totaling $0 and $379 in the three months ended March 31, 2003 and 2002,
respectively.
The accompanying unaudited notes to condensed consolidated financial statements
are an integral part of these financial statements.
3
THE ULTIMATE SOFTWARE GROUP, INC. AND SUBSIDIARY
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
1. BASIS OF PRESENTATION
The accompanying condensed consolidated financial statements of The
Ultimate Software Group, Inc. and subsidiary (the "Company") have been prepared,
without audit, pursuant to the rules and regulations of the Securities and
Exchange Commission (the "SEC"). Certain information and footnote disclosures
normally included in financial statements in accordance with accounting
principles generally accepted in the United States have been condensed or
omitted pursuant to such rules and regulations. The information in this report
should be read in conjunction with the Company's consolidated audited financial
statements and notes thereto included in the Company's Annual Report on Form
10-K for the fiscal year ended December 31, 2002 filed with the SEC on March 31,
2003 (the "Form 10-K").
The unaudited condensed consolidated financial statements included
herein reflect all adjustments (consisting only of normal, recurring
adjustments), which are, in the opinion of the Company's management, necessary
for a fair presentation of the information for the periods presented. The
preparation of financial statements in conformity with accounting principles
generally accepted in the United States requires management to make estimates
and assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates. Interim
results of operations for the three months ended March 31, 2003 and 2002 are not
necessarily indicative of operating results for the full fiscal years or for any
future periods.
Reclassifications
Certain reclassifications have been made to prior year balances to
conform to the current year presentation.
2. LIQUIDITY AND CAPITAL RESOURCES
The Company's cash flows from operations have historically been
insufficient to fund its operations. Shortfalls in cash flows from operations
have been funded primarily through the private and public sale of equity
securities and, to a lesser extent, equipment financing and borrowing
arrangements.
On January 23, 2003, the Company raised $0.2 million of capital through
the private sale of 50,000 shares of the Company's common stock, par value $0.01
per share ("Common Stock"), and a warrant to purchase 5,000 shares of Common
Stock at $4 per share to a shareholder of the Company. On March 13, 2003, the
Company raised an additional $3.0 million of capital through the private sale of
750,000 shares of the Company's Common Stock and a warrant to purchase 75,000
shares of Common Stock at $4 per share to Ceridian Corporation ("Ceridian"). The
additional capital raised in January 2003 and March 2003 is collectively
referred to as "Recent Capital Raised."
On February 10, 2003, the Company entered into a services agreement
with Ceridian (the "Ceridian Services Agreement") under which Ceridian will pay
Ultimate Software a total of $2.25 million in four equal installments during
each of the calendar quarters of 2003 in exchange for additional services
provided by Ultimate Software in 2003. The Company received a payment of
$562,500 from Ceridian during March 2003. The Ceridian Services Agreement
terminates on December 31, 2003.
4
On March 27, 2003, the Company amended its revolving line of credit
agreement with Silicon Valley Bank (the "Credit Facility") to extend the
expiration date of the agreement to May 28, 2004. The Company was not in
compliance with the Quick Ratio financial covenant of the Credit Facility, as
defined in the Credit Facility (the "Quick Ratio"), for the month ended March
31, 2003. On April 29, 2003, the Company and Silicon Valley Bank amended the
Credit Facility to modify the Quick Ratio by reducing the requirement from a
ratio of 2.0 to 1.0 to 1.75 to 1.0. This loan modification was effective for the
month ended March 31, 2003 and each month thereafter through the revised
expiration date of May 28, 2004. As a result of the loan modification, the
Company is in compliance with all debt covenants pursuant to the Credit
Facility, as amended from time to time.
The Company believes that cash and cash equivalents, cash generated
from operations and available borrowings under the existing revolving line of
credit with Silicon Valley Bank 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, improvements in gross
margins, controlled operating expenses and collections of accounts receivable.
However, the Company may seek to raise additional funds during such period
through the sale of additional shares of the Company's common stock, par value
$0.01, or other securities. There can be no assurance that the Company will be
able to raise such funds on terms acceptable to the Company.
3. CONCENTRATION OF REVENUES
During the three months ended March 31, 2003, one of the Company's
customers, Ceridian, accounted for 15.8% of total revenues. No other customer
accounted for more than 10% of total revenues in 2003 or 2002.
Of the 15.8% of total revenues recognized from Ceridian, 13.4% relates
to recurring revenue recognized pursuant to the Original Ceridian Agreement,
discussed below, and 2.4% relates to services revenue recognized under the
Ceridian Services Agreement (see Note 2).
During 2001, the Company and Ceridian reached an agreement, as amended
in 2002, which granted Ceridian a non-exclusive license to use Ultimate
Software's UltiPro Workforce Management Software ("UltiPro") software as part of
an on-line offering that Ceridian intends to market primarily to businesses with
under 500 employees (the "Original Ceridian Agreement"). The aggregate minimum
payments that Ceridian is obligated to pay the Company under the Original
Ceridian Agreement over the minimum term of the agreement is $42.7 million. To
date, Ceridian has paid to the Company a total of $16.5 million under the
Original Ceridian Agreement. The earliest date upon which the Ceridian Agreement
can be terminated by either party (except for an uncured material breach) is
March 9, 2008, resulting in an expected minimum term of 7 years (the "Minimum
Term"). Ceridian retains certain rights to use the software upon termination. A
minimum of approximately $642,000 has been and will be recognized as
subscription revenue, a component of recurring revenue, on a monthly basis, from
the Original Ceridian Agreement for the period beginning August 28, 2002 through
the end of the Minimum Term.
Services revenue from the Ceridian Services Agreement is recognized on
a straight-line basis from the date of the agreement, February 10, 2003, through
the expiration of such agreement, or December 31, 2003.
4. COMPREHENSIVE INCOME
Statement of Financial Accounting Standards ("SFAS") No. 130,
"Reporting Comprehensive Income," establishes standards for the reporting and
display of comprehensive income and its components in a full set of financial
statements. The objective of SFAS No. 130 is to report a measure (comprehensive
income) of all changes in equity of an enterprise that result from transactions
and other economic events in a period other than transactions with owners.
Comprehensive loss is equal to net loss for all periods presented.
5
5. EARNINGS PER SHARE
The following is a reconciliation of the shares used in the computation
of basic and diluted net loss per share (in thousands):
FOR THE THREE MONTHS
ENDED MARCH 31,
---------------
2003 2002
---- ----
Weighted average shares outstanding 16,718 15,885
Effect of dilutive stock options - -
------ ------
Dilutive shares outstanding 16,718 15,885
====== ======
Options outstanding which are not included in the
calculation of diluted loss per share
because their impact is antidilutive 5,295 4,690
====== ======
6. STOCK-BASED COMPENSATION
The Company accounts for employee stock options in accordance with
Accounting Principles Board ("APB") No. 25, "Accounting for Stock Issued to
Employees" ("APB 25"). Under APB 25, the Company recognizes no compensation
expense related to employee stock options since options are granted at a price
equal to the market price of the underlying stock on the date of grant.
The Company's Nonqualified Stock Option Plan (the "Plan") authorizes
the grant of options to directors, officers and employees of the Company for up
to 9,000,000 shares of the Company's Common Stock. As of March 31, 2003,
3,460,145 shares of the Company's Common Stock are available for grant. Options
granted generally have a 10-year term, vesting 25% immediately and 25% for each
of the following three years.
The pro forma information below is based on provisions of Statement of
Financial Accounting Standard ("SFAS") No. 123, "Accounting for Stock-Based
Compensation ("SFAS No. 123"), as amended by SFAS No. 148, "Accounting for
Stock-Based Compensation - Transition and Disclosure" ("SFAS No. 148").
6
The following pro forma information regarding net loss and net loss per
share, as required by SFAS No. 123, has been determined as if the Company had
accounted for its stock-based compensation plan under the fair value method. The
fair value of each option granted was estimated at the date of grant using the
Black-Scholes option pricing model with the following weighted average
assumptions used for grants: risk-free interest rates of 2.84% for 2003 and
2.72% for 2002, a dividend yield of 0% for all periods presented, expected
volatility of 46% for 2003 and 68% for 2002 and an expected life of four years
for each of the periods presented. The Company's pro forma information is as
follows (in thousands, except per share amounts):
FOR THE THREE MONTHS
ENDED MARCH 31,
2003 2002
-------- --------
Net loss:
As reported $(2,636) $(5,723)
Stock-based employee compensation as determined under
fair value method for all awards (493) (547)
------- -------
Pro forma $(3,129) $(6,270)
======= =======
Net loss per share:
As reported, basic and diluted $ (0.16) $ (0.36)
Pro forma, basic and diluted $ (0.19) $ (0.39)
7. RECENT ACCOUNTING LITERATURE
SFAS No. 148, issued in December 2002, amends SFAS No. 123, to provide
alternative methods of transition for a voluntary change to the fair-value-based
method of accounting for stock-based employee compensation. In addition, this
Statement amends the disclosure requirements of SFAS 123 to require prominent
disclosures in not only annual, but also interim, financial statements about the
effect the fair value method would have had on reported results. The transition
and annual disclosure requirements of SFAS No. 148 are effective for fiscal
years ending after December 15, 2002. The Company adopted the disclosure
provisions of SFAS No. 148 as of January 1, 2003 and continues to follow APB No.
25 in accounting for employee stock options.
In November 2002, the FASB issued Interpretation No. 45, "Guarantor's
Accounting and Disclosure Requirements for Guarantees, Including Indirect
Guarantees of Indebtedness of Others," ("FIN 45"). FIN 45 expands previously
issued accounting guidance and disclosure requirements for certain guarantees
and requires recognition of an initial liability for the fair value of an
obligation assumed by issuing a guarantee. The provision for initial recognition
and measurement of liability will be applied on a prospective basis to
guarantees issued or modified after December 31, 2002. The Company adopted FIN
45 as of January 1, 2003. Adoption did not have a material impact on the
Company's unaudited consolidated financial statements.
In January 2003, the FASB issued Interpretation No. 46, "Consolidation
of Variable Interest Entities," ("FIN 46"). FIN 46 clarifies the application of
Accounting Research Bulletin No. 51, "Consolidated Financial Statements," for
certain entities that do not have sufficient equity at risk for the entity to
finance its activities without additional subordinated financial support from
other parties or in which equity investors do not have the characteristics of a
controlling financial interest ("variable interest entities"). Variable interest
entities within the scope of FIN 46 will be required to be consolidated by their
primary beneficiary. The primary beneficiary of a variable interest entity is
determined to be the party that absorbs a majority of the entity's expected
losses, receives a majority of its expected returns, or both. FIN 46 applies
immediately to variable interest entities created after January 31, 2003, and to
variable interest entities in which an enterprise obtains an interest after that
date. It applies in the first fiscal year or interim period beginning after June
15, 2003, to variable interest entities in which an enterprise holds a variable
interest that it acquired before February 1, 2003. The Company is currently
evaluating
7
the impact of adopting FIN 46. However, the Company does not believe that it is
party to any arrangement that would fall within the scope of FIN 46.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following discussion of the financial condition and results of
operations of The Ultimate Software Group, Inc. ("Ultimate Software" or the
"Company") should be read in conjunction with the unaudited Condensed
Consolidated Financial Statements and Notes thereto included elsewhere in this
Form 10-Q. This Form 10-Q contains forward-looking statements that involve risks
and uncertainties. The Company's actual results could differ materially from
those contained in the forward-looking statements. Factors that may cause such
differences include, but are not limited to, those discussed below and in the
Company's Annual Report on Form 10-K for the fiscal year ended December 31, 2002
filed with the SEC on March 31, 2003, including Exhibit 99.1 thereto. The
Company undertakes no obligation to publicly update or revise any
forward-looking statements, whether as a result of new information, future
events or otherwise.
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:
- Sales of perpetual licenses for UltiPro Workforce Management Software
("UltiPro"), a Web-based solution designed to deliver the functionality
businesses need to manage the employee life cycle, whether their
processes are centralized at headquarters or distributed across
multiple divisions or branch offices;
- Sales of perpetual licenses for UltiPro in conjunction with services to
host the UltiPro application (or "Hosting Services");
- Sales of the right to use UltiPro, including Hosting Services (the
"Intersourcing Offering");
- Sales of Hosting Services on a stand-alone basis to customers who
already own a perpetual license or are simultaneously acquiring a
perpetual license for UltiPro, or ("Base Hosting");
- Sales of other services including implementation, training and other
services, including the provision of payroll-related forms and the
printing of Form W-2's for certain customers; and
- Recurring revenues derived from (1) maintenance revenues generated from
maintaining, supporting and providing periodic updates for the
Company's software and (2) subscription revenues generated from per
employee per month ("PEPM") fees earned through the Intersourcing
Offering, Base Hosting and the business service provider (BSP) sales
channel (defined below), as well as revenues generated from the
Original Ceridian Agreement.
Perpetual Licenses for UltiPro Sold With or Without Hosting Services
Sales of perpetual licenses for UltiPro and sales of perpetual licenses
for UltiPro in conjunction with Hosting Services are multiple-element
arrangements that involve the sale of software and consequently fall under the
guidance of SOP 97-2 for revenue recognition.
The Company licenses software under non-cancelable license agreements
and provides services including maintenance, training and implementation
consulting services. In accordance with the provisions of
8
Statement of Position ("SOP") 97-2, "Software Revenue Recognition," license
revenues are generally recognized when (1) a non-cancelable license agreement
has been signed by both parties, (2) the product has been shipped, (3) no
significant vendor obligations remain and (4) collection of the related
receivable is considered probable. To the extent any one of these four criteria
is not satisfied, license revenue is deferred and not recognized in the
consolidated statements of operations until all such criteria is 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 element 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 is used to recognize revenue when a license
agreement includes one or more elements to be delivered at a future date and
vendor specific objective evidence of the fair value of all undelivered elements
exists. The fair value of the undelivered elements is determined based on the
historical evidence of stand-alone sales of these elements to third parties.
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,
defined below, are recognized in accordance with Emerging Issues Task Force
("EITF") No. 00-21, "Revenue Arrangements with Multiple Deliverables" as a
services arrangement since the customer is purchasing the right to use UltiPro
rather than licensing the software on a perpetual basis. Fair value of multiple
elements in Intersourcing arrangements is assigned to each element based on the
guidance provided by EITF 00-21.
The elements that typically exist in Intersourcing arrangements include
hosting services, the right to use UltiPro, maintenance of UltiPro (i.e.,
product enhancements and customer support) and professional services (i.e.,
implementation services and training in the use of UltiPro). The pricing for
hosting services, the right to use UltiPro and maintenance of UltiPro is bundled
(the "Bundled Elements"). Since these three Bundled Elements are components of
recurring revenues in the consolidated statements of operations, allocation of
fair values to each of the three elements is not necessary since they are not
reported separately. Fair value for the Bundled Elements, as a whole, is based
upon evidence provided by the Company's pricing for Intersourcing arrangements
sold separately. The Bundled Elements are provided on an ongoing basis and
represent undelivered elements under EITF 00-21; they are recognized on a
monthly basis as the services are performed, once the customer has begun to
process payrolls used to pay their employees (i.e., goes "Live").
Implementation and training services (the "Professional Services")
provided for Intersourcing arrangements are priced on a time and materials basis
and are recognized as services revenue in the consolidated statements of
operations as the services are performed. Under EITF 00-21, fair value is
assigned to service elements in the arrangement based on their relative fair
values, using the prices established when the services are sold on a stand-alone
basis. 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.
9
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 Stored on Another Entity's
Hardware," which provides guidance as to the application of SOP 97-2 to hosting
arrangements that include a license right to the software. The elements that
typically exist for Base Hosting arrangements include hosting services and
implementation services. Base Hosting is different than Intersourcing
arrangements (described above) in that the customer already owns a perpetual
license or is purchasing a perpetual license for UltiPro and is purchasing
hosting services subsequently in a separate transaction whereas, with
Intersourcing, the customer is purchasing the right to use (not license)
UltiPro. Implementation services provided for Base Hosting arrangements are
substantially less than those provided for Intersourcing arrangements since
UltiPro is already implemented in Base Hosting arrangements and only needs to be
transitioned to a hosted environment. Fair value for hosting services is based
on the Hosting Valuation. Fair value for implementation services is assigned in
accordance with guidelines provided by SOP 97-2 based on the Implementation
Valuation.
Other Services, including Implementation and Training Services
Services revenues include revenues from fees charged for the
implementation of the Company's software products and training of customers in
the use of such products, fees for other services, including the provision of
payroll-related forms and the printing of Form W-2's for certain customers, as
well as certain reimbursable out-of-pocket expenses. Revenues for training and
implementation consulting services are recognized as services are performed.
Other services are recognized as the product is shipped or as the services are
rendered.
Arrangement fees related to fixed-fee implementation services contracts
are recognized using the percentage of completion accounting method, which
involves the use of estimates. Percentage of completion is measured at each
reporting date based on hours incurred to date compared to total estimated hours
to complete. If a sufficient basis to measure the progress towards completion
does not exist, revenue is recognized when the project is completed or when we
receive final acceptance from the customer.
Recurring Revenues
Recurring revenues include maintenance revenues and subscription
revenues. Maintenance revenues are derived from maintaining, supporting and
providing periodic updates for the Company's software. Subscription revenues are
principally derived from per employee per month ("PEPM") fees earned through the
Intersourcing Offering (defined below), hosting services offered to customers
that license UltiPro on a perpetual basis ("Base Hosting") and the business
service provider (BSP) sales channel (defined below), as well as revenues
generated from the Original Ceridian Agreement. Maintenance revenues are
recognized ratably over the service period, generally one year. Maintenance and
support fees are generally priced as a percentage of the initial license fee for
the underlying products. 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 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 approximately $642,000 per month are based on guaranteed minimum
payments from Ceridian Corporation of approximately $42.7 million over the
contract term, including $16.5 million received to date.
10
Maintenance services provided to customers include product updates and
technical support services. Product updates are included in general releases to
the Company's customers and are distributed on a periodic basis. Such updates
may include, but are not limited to, product enhancements, payroll tax updates,
additional security features or bug fixes. All features provided in general
releases are unspecified upgrade rights. To the extent specified upgrade rights
or entitlements to future products are included in a multi-element arrangement,
revenue is recognized upon delivery provided fair value for the elements exists.
In multi-element arrangements that include a specified upgrade right or
entitlement to a future product, if fair value does not exist for all
undelivered elements, revenue for the entire arrangement is deferred until all
elements are delivered or when fair value can be established.
Subscription revenues generated from the BSP sales channel include both
the right to use UltiPro and maintenance. The BSP is charged a fee on a per
employee per month basis and, in several cases, is subject to a monthly minimum
amount for the term of the related agreement. Revenue is recognized on a per
employee per month basis. The Company generally does not host UltiPro for the
BSP sales channel.
The Company recognizes revenue in accordance with the SEC Staff
Accounting Bulletin No. 101, "Revenue Recognition in Financial Statements" ("SAB
No. 101"). Management believes the Company is currently in compliance with the
current provisions set forth in SOP 97-2, SOP 98-9, EITF 00-21, EITF 00-3 and
SAB No. 101.
Concentration of Revenues
During the three months ended March 31, 2003, one of the Company's
customers, Ceridian Corporation, accounted for 15.8% of total revenues. No other
customer accounted for more than 10% of total revenues in 2003 or 2002. Due to
the significant concentration of total revenues with this single customer, the
Company has exposure if this customer loses its credit worthiness. See Note 3 of
the unaudited Notes to Condensed Consolidated Financial Statements.
Allowance for Doubtful Accounts
The Company maintains an allowance for doubtful accounts at an amount
estimated to be sufficient to provide adequate protection against losses
resulting from collecting less than full payment on accounts receivables. In
assessing the adequacy of the allowance for doubtful accounts, the Company
considers multiple factors including historical bad debt experience, the general
economic environment, and the aging of its receivables. A considerable amount of
judgment is required when the realization of receivables is assessed, including
assessing the probability of collection and current credit-worthiness of each
customer. If the financial condition of the Company's customers were to
deteriorate, resulting in an impairment of their ability to make payments, an
additional provision for doubtful accounts may be required.
Software Development Costs
SFAS No. 86, "Accounting for the Costs of Computer Software to be Sold,
Leased or Otherwise Marketed," requires capitalization of certain software
development costs subsequent to the establishment of technological feasibility.
Based on the Company's product development process, technological feasibility is
established upon completion of a working model. There were no software costs
capitalized during 2003 and 2002. Annual amortization is based on the greater of
the amount computed using (a) the ratio that current gross revenues for the
related product bears to the total of current and anticipated future gross
revenues for that product or (b) the straight-line method over the remaining
estimated economic life of the product including the period being reported on.
Capitalized software is amortized using the straight-line method over the
estimated useful lives of the assets which are typically three years.
Amortization of capitalized software was $380,000 and $455,000 for the three
months ending March 31, 2003 and 2002, respectively. Accumulated amortization of
capitalized software was $3.3 million for the period ended March 31, 2003 and
$1.6 million for the period ended March 31, 2002. The Company
11
evaluates the recoverability of capitalized software based on estimated future
gross revenues reduced by the estimated costs of completing the products and of
performing maintenance and customer support. If the Company's gross revenues
were to be significantly less than its estimates, the net realizable value of
the Company's capitalized software intended for sale would be impaired, which
could result in the write-off of all or a portion of the unamortized balance of
such capitalized software.
OVERVIEW
Ultimate Software designs, markets, implements and supports payroll and
workforce management solutions.
Ultimate Software's UltiPro Workforce Management Software ("UltiPro")
is a Web-based solution designed to deliver the functionality businesses need to
manage the employee life cycle, whether their processes are centralized at
headquarters or distributed across multiple divisions or branch offices.
UltiPro's human resources ("HR") and benefits management functionality is wholly
integrated with a flexible payroll engine, reporting and analytical
decision-making tools, and a central Web portal that can serve as the customer's
gateway for its workforce to access company-related and personal information.
Ultimate Software believes that UltiPro helps customers streamline HR and
payroll processes to significantly reduce administration and operational costs,
while also empowering executives and staff to access critical information
quickly and perform routine business activities efficiently.
UltiPro 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 on companies with more than 500 employees
and sells both on a license (typically in-house) and service basis (typically
hosted and priced on a per-employee-per-month basis). The Company's BSP
alliances focus primarily on companies with under 500 employees and typically
sell an Internet solution, 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 monthly
minimum amount.
The Company's direct sales force markets UltiPro as an in-house payroll
and workforce management solution and alternatively as the Intersourcing
Offering. Intersourcing provides Web access to comprehensive workforce
management functionality for organizations that need to simplify the information
technology (IT) support requirements of their business applications. Ultimate
Software believes that Intersourcing is attractive to companies that are
striving to focus on their core competencies to increase sales and profits.
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.
Intersourcing Offering
In 2002, the Company introduced the Intersourcing Offering, which is a
hosting service through which the Company provides the hardware, infrastructure,
ongoing maintenance and back-up services for its customers at a BellSouth data
center. 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, available in a shared or dedicated
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 a shared environment, commonly used for
Intersourcing, 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. In a dedicated environment,
servers are dedicated to specific customers that purchase this particular
service. The majority of the Company's hosting arrangements are provided through
a shared environment.
12
The Intersourcing Offering is designed to provide an appealing pricing
structure to customers who prefer to minimize the initial cash outlay associated
with typical capital expenditures. Intersourcing customers purchase the right to
use UltiPro on an ongoing basis for a specific term in a shared or dedicated
hosted environment. The pricing for Intersourcing, including both the hosting
element as well as the right to use UltiPro, is on a per-employee-per-month
basis.
Ceridian Services Agreement
On February 10, 2003, Ultimate Software entered into a services
agreement (the "Ceridian Services Agreement") with Ceridian Corporation
("Ceridian"). Under the Ceridian Services Agreement, Ultimate Software is,
through December 31, 2003, required to:
1) locate an employee at Ceridian's office in Atlanta, Georgia dedicated
to assist Ceridian in the resolution of any issues concerning the
development, integration and troubleshooting of UltiPro as used by
Ceridian;
2) provide work space at Ultimate Software's headquarters in Weston,
Florida for an employee of Ceridian for the purpose of ongoing
coordination and understanding of general and technical product
requirements, integration requirements and general communication of
development status and issue resolution;
3) allow Ceridian to provide input related to development plans (with no
approval rights granted to Ceridian and without any obligation on
Ultimate Software's part to incorporate such input into its development
plans) for UltiPro and to grant Ceridian access to the early stages of
upcoming product releases; and
4) test methodologies which could extend performance and scalability of
UltiPro in the service bureau environment and consider methodologies
which can improve performance and scalability.
Ceridian is required to pay Ultimate Software a total of $2.25 million
in four equal installments during each calendar quarter of 2003 in exchange for
the services provided by Ultimate Software. Ceridian paid Ultimate Software the
first installment of $562,500 during March 2003. Services revenue is recognized
on a straight-line basis from February 10, 2003 through December 31, 2003.
Original Ceridian Agreement
During 2001, Ultimate Software and Ceridian reached an agreement, as
amended in 2002, which granted Ceridian a non-exclusive license to use UltiPro
software as part of an on-line offering that Ceridian intends to market
primarily to businesses with under 500 employees (the "Original Ceridian
Agreement"). The aggregate minimum payments that Ceridian is obligated to pay
Ultimate Software under the Original Ceridian Agreement over the minimum term of
the agreement is $42.7 million. To date, Ceridian has paid to Ultimate Software
a total of $16.5 million under the Original Ceridian Agreement. The earliest
date upon which the Ceridian Agreement can be terminated by either party (except
for an uncured material breach) is March 9, 2008, resulting in an expected
minimum term of 7 years. Ceridian retains certain rights to use the software
upon termination.
Company Background
The Company is a Delaware corporation formed in April 1996 to assume
the business and operations of The Ultimate Software Group, Ltd., a limited
partnership founded in 1990. Ultimate Software's headquarters are located at
2000 Ultimate Way, Weston, Florida 33326 and its telephone number is (954)
331-7000. To date, the Company derives no revenue from customers outside of the
United States and has no assets located outside of the United States.
13
RESULTS OF OPERATIONS
The following table sets forth the Statement of Operations data of the
Company, as a percentage of total revenues, for the periods indicated.
For the Three Months
Ended March 31,
--------------------
2003 2002
---- ----
Revenues:
License 8.4% 12.7%
Recurring 47.7 35.9
Services 43.9 51.4
----- -----
Total revenues 100.0 100.0
----- -----
Cost of revenues:
License 1.7 1.3
Recurring 15.9 17.8
Services 30.8 41.6
----- -----
Total cost of revenues 48.4 60.7
----- -----
Operating expenses:
Sales and marketing 28.4 41.4
Research and development 30.1 39.5
General and administrative 11.2 10.3
----- -----
Total operating expenses 69.7 91.2
----- -----
Operating loss (18.1) (51.9)
Interest expense (0.3) (0.6)
Interest and other income 0.1 0.3
----- -----
Net loss (18.3)% (52.2)%
===== =====
Revenues
The Company's revenues are derived from three principal sources:
software licenses ("license revenues"), recurring revenues and services
revenues.
License revenues include revenues from software license agreements for
the Company's products, entered into between the Company and its customers in
which the license fees are noncancellable. License revenues are generally
recognized upon the delivery of the related software product when all
significant contractual obligations have been satisfied. Until such delivery,
the Company records amounts received when contracts are signed as customer
deposits that are included with deferred revenues in the condensed consolidated
balance sheets.
Recurring revenues include maintenance and subscription revenues.
Maintenance revenues are derived from maintaining, supporting and providing
periodic updates for the Company's software. Subscription revenues are
principally derived from per employee per month ("PEPM") fees earned through the
Intersourcing Offering, Base Hosting and the BSP sales channel, as well as
revenues generated from the Original Ceridian Agreement. Maintenance revenues
are recognized ratably over the service period, generally one year. Subscription
revenues are recognized ratably over the term of the related contract upon the
delivery of the product and services. All of the Company's customers that
purchased software during 2003 and 2002 also purchased maintenance and support
service contracts. Maintenance and support fees are generally priced as a
percentage of the initial license fee for the underlying products.
Services revenues include revenues from fees charged for the
implementation of the Company's software products and training of customers in
the use of such products, fees for other services, including the provision of
payroll-related forms and the printing of Form W-2's for certain customers, as
well as revenue
14
generated from the Ceridian Services Agreement and certain reimbursable
out-of-pocket expenses. Service revenues are recognized as services are
performed and delivered.
Total revenues, consisting of license, recurring and services revenues,
increased 31.5% to $14.4 million for the three months ended March 31, 2003 from
$11.0 million for the three months ended March 31, 2002.
License revenues decreased 13.1% to $1.2 million for the three months
ended March 31, 2003 from $1.4 million for the three months ended March 31,
2002. The decrease in license revenues for the three-month period was primarily
due to a reduction in the number of units sold by the Company's direct sales
channel during the first quarter of 2003. The reduction in the number of license
units sold was due to a decrease in sales of UltiPro to existing clients using
the Company's DOS-based product, UltiPro for Lan ("DOS Clients"). Sales of the
UltiPro product to DOS Clients ended during the last fiscal quarter of 2002,
shortly before support services for UltiPro for Lan were discontinued (in
January 2003). Prior to discontinuing support services, 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 services
for UltiPro for Lan were discontinued. More than half of the DOS Clients
converted to the UltiPro product in 2002.
Recurring revenues increased 74.4% to $6.9 million for the three months
ended March 31, 2003 from $3.9 million for the three months ended March 31,
2002. The increase in the three month period is primarily due to (i) the
recognition of subscription revenue, beginning on August 28, 2002, under the
Original Ceridian Agreement, as amended from time to time, (ii) an increase in
maintenance revenues generated from incremental licenses sold in 2002 and, to a
lesser extent, (iii) revenues recognized pursuant to the Intersourcing Offering,
which was introduced in 2002.
Services revenues increased 12.5% to $6.3 million for the three months
ended March 31, 2003 from $5.6 million for the three months ended March 31,
2002. The increase in services revenues for the three-month period was
principally due to the revenue recognized under the Ceridian Services Agreement
beginning February 10, 2003, and, to a lesser extent, an increase in
reimbursable out-of-pocket expenses and an increase in training revenues.
Cost of Revenues
Cost of revenues consists of the cost of license, recurring and
services revenues. Cost of license revenues primarily consists of fees payable
to a third party for software products distributed by the Company and, to a
lesser degree, amortization of capitalized software costs. UltiPro includes
third-party software for enhanced report writing purposes. When UltiPro licenses
are sold, customers pay the Company on a per user basis for the license rights
to the third-party report writing software. Capitalized software is amortized
using the straight-line method over the estimated useful life of the related
asset, which is typically three years. Cost of recurring revenues consists of
costs to provide maintenance and technical support to the Company's customers,
the cost of periodic updates and the costs of subscription revenues, including
costs associated with the Intersourcing Offering and 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, costs related to sales of payroll-related forms and costs
associated with reimbursable out-of-pocket expenses.
Total cost of revenues, consisting of license, recurring and services
revenues, increased 4.8% to $7.0 million for the three months ended March 31,
2003 from $6.6 million for the three months ended March 31, 2002.
Cost of license revenues increased 73.6 % to $243,000 for the three
months ended March 31, 2003 from $140,000 for the three months ended March 31,
2002 primarily due to an increase in third party fees. Cost of license revenues,
as a percentage of license revenues, increased to 20.0% for the three months
ended March 31, 2003 as compared to 10.0% for the three months ended March 31,
2002 principally due to lower license revenues.
15
Cost of recurring revenues increased 14.2% to $2.3 million for the
three months ended March 31, 2003 from $2.0 million for the three months ended
March 31, 2002. The increase in the three-month period was primarily
attributable to costs associated with the Intersourcing Offering, including
depreciation and amortization of related computer equipment, and increased costs
of maintenance revenues principally due to higher labor costs. Cost of recurring
revenues, as a percentage of recurring revenues, decreased to 33.4% for the
three months ended March 31, 2003 as compared to 49.6% for the three months
ended March 31, 2002. The decrease in the three-month period ended March 31,
2003 was primarily a result of the absorption of these costs into an increased
recurring revenue base.
Cost of services revenues decreased 2.7 % to $4.4 million for the three
months ended March 31, 2003 from $4.6 million for the three months ended March
31, 2002. The decrease in the three-month period was primarily due to lower
labor costs for implementation services. Cost of services revenues, as a
percentage of services revenues, for the three months ended March 31, 2003
decreased to 70.1% as compared to 81.0% for the three months ended March 31,
2002. The decrease in the three-month period was primarily due to a reduction in
the labor costs as well as an expanded services revenue base.
Sales and Marketing
Sales and marketing expenses consist primarily of salaries, sales
commissions, travel and promotional expenses, and facility and communication
costs for direct sales offices, as well as advertising and marketing costs.
Sales and marketing expenses decreased 9.9 % to $4.1 million for the three
months ended March 31, 2003 from $4.5 million for the three months ended March
31, 2002 primarily due to lower labor costs, including sales commissions. Sales
and marketing expenses, as a percentage of total revenues, decreased to 28.4% as
compared to 41.4% for the three months ended March 31, 2003 and 2002,
respectively. The decrease in the three-month period was primarily a result of
the combination of a reduction in labor costs and an increase in the total
revenue base.
Research and Development
Research and development expenses consist primarily of software
development personnel costs. Research and development expenses of $4.3 million
for the three-month period ended March 31, 2003 were consistent with the prior
year comparable period. A slight increase in labor costs, principally benefit
costs, was offset by a decrease in the amortization of capitalized software due
to the cessation of the capitalizable period for certain software. Research and
development expenses, as a percentage of total revenues, decreased to 30.0% for
the three months ended March 31, 2003 as compared to 39.5% for the period ended
March 31, 2002 principally due to the absorption of these costs in an increased
total revenue base.
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 43.2% to $1.6 million for the three months
ended March 31, 2003 from $1.1 million for the three months ended March 31,
2002. General and administrative expenses, as a percentage of total revenues,
increased to 11.2% for the three months ended March 31, 2003 as compared to
10.3% for the three months ended March 31, 2002. The increase in general and
administrative expenses was primarily due to an increase in the provision for
doubtful accounts and higher professional fees principally as a result of
compliance with recent corporate governance rules.
16
Interest Expense
Interest expense decreased 26.4% to $53,000 for the three months ended
March 31, 2003 from $72,000 for the three months ended March 31, 2002. The
decrease in interest expense for the three-month period was primarily due to a
decrease in capital lease obligations.
Interest and Other Income
Interest and other income decreased 50.0% to $20,000 for the three
months ended March 31, 2003 from $40,000 for the three months ended March 31,
2002. The decrease in interest and other income for the three-month period was
primarily due to the reduction of funds available for investment in 2003.
Income Taxes
No provision or benefit for federal, state or foreign income taxes was
made for the three months ended March 31, 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, 2002 expire
at various times through the year 2022, and are available to offset future
taxable income. The timing and levels of future profitability may result in the
expiration of net operating loss carryforwards before utilization. Additionally,
utilization of such net operating losses may be limited as a result of
cumulative ownership changes in the Company's equity instruments.
LIQUIDITY AND CAPITAL RESOURCES
The Company's cash flows from operations have historically been
insufficient to fund its operations. Shortfalls in cash flows from operations
have been funded primarily through the private and public sale of equity
securities and, to a lesser extent, equipment financing and borrowing
arrangements.
As of March 31, 2003, the Company had $8.4 million in cash and cash
equivalents, reflecting a net decrease of $0.6 million since December 31, 2002.
The working capital deficit was $10.7 million and $9.7 million as of March 31,
2003 and December 31, 2002, respectively. The decrease in working capital
resulted primarily from the funding of operations, partially offset by Recent
Capital Raised, as defined below.
Net cash used in operating activities was $2.8 million for the three
months ended March 31, 2003 as compared to cash provided by operating activities
of $4.4 million for the three months ended March 31, 2002. During February 2002,
the Company received $6.0 million from Ceridian as a prepayment by Ceridian of
minimum guaranteed payments for 2003 due to the Company pursuant to the Original
Ceridian Agreement, as amended from time to time. During the three months ended
March 31, 2003, the Company received $0.6 million from Ceridian pursuant to the
Ceridian Services Agreement.
Net cash used in investing activities totaling $0.6 million for the
three months ended March 31, 2003 was consistent with the prior year comparable
period due to similar capital expenditures for both periods.
Net cash provided by financing activities for the three months ended
March 31, 2003 was $2.8 million as compared to net cash used in financing
activities of $0.7 million for the three months ended March 31, 2002. The
increase in net cash provided by financing activities was primarily due to the
proceeds from Recent Capital Raised.
Days sales outstanding, calculated on a trailing three-month basis
("DSO"), as of March 31, 2003 and 2002, were 49 days and 80 days, respectively.
The decrease in DSO's in 2003 was the result of (1) the recognition of
additional subscription revenue in the three months ended March 31, 2003 (i.e.,
increase of $1.9 million from the same period in 2002) from the Original
Ceridian Agreement which does not have related accounts receivable; (2)
17
an improvement in the quality of accounts receivable; and (3) the Company's
change in business strategy to focus on both license sales (as in the past) and
Intersourcing sales (beginning in 2002 and strengthening in 2003).
During the first quarter of 2003, the Company raised an aggregate total
of $3.2 million of capital through the private sales of 800,000 shares of the
Company's Common Stock and warrants to purchase 80,000 shares of the Company's
Common Stock at $4 per share ("Recent Capital Raised"). As the Company's revenue
mix shifts from license revenue to recurring revenue, particularly through the
Intersourcing Offering, and cash inflow consequently shifts from relatively
large, one-time upfront payments to recurring monthly payments, the Company may
continue to seek to raise additional funds through the sale of additional shares
of Common Stock or other securities.
The Company has a revolving line of credit (the "Credit Facility") with
Silicon Valley Bank, which is secured by all of the Company's assets, including
a negative pledge on intellectual property, and bears interest at a rate equal
to Prime Rate plus 1.0% per annum (reduced to Prime Rate plus 0.5% per annum
upon two consecutive quarters of net profitability). The Credit Facility
provides working capital financing for up to 75% of the Company's eligible
accounts receivable, as defined, financing for eligible equipment purchases for
up to $2.5 million with additional limits for software purchases, and stand-by
letters of credit for up to $0.5 million. The maximum amount available under the
Credit Facility is $5.0 million. The Credit Facility, as amended, expires on May
28, 2004. As of March 31, 2003, the Company had $1.2 million outstanding under
the eligible equipment purchases portion of the Credit Facility, with an
aggregate of $3.8 million available under the Credit Facility. The Company was
not in compliance with the Quick Ratio financial covenant of the Credit
Facility, as defined in the Credit Facility (the "Quick Ratio"), for the month
ended March 31, 2003. On April 29, 2003, the Company and Silicon Valley Bank
amended the Credit Facility to modify the Quick Ratio by reducing the
requirement from a ratio of 2.0 to 1.0 to 1.75 to 1.0. This loan modification
was effective for the month ended March 31, 2003 and each month thereafter
through the revised expiration date of May 28, 2004. As a result of the loan
modification, the Company is in compliance with all debt covenants pursuant to
the Credit Facility, as amended from time to time. Under the terms of the Credit
Facility, no dividends may be paid on the Company's Common Stock without the
consent of Silicon Valley Bank.
The Company believes that cash and cash equivalents, cash generated
from operations, including Recent Capital Raised, and available borrowings under
the Credit Facility will be sufficient to fund its operations for at least the
next 12 months. This belief is based upon, among other factors, management's
expectations for future revenue growth, improvements in gross margins,
controlled operating expenses and collections of accounts receivable. However,
as discussed above, the Company may seek to raise additional funds during such
period through the sale of additional shares of Common Stock or other
securities. There can be no assurance that the Company will be able to raise
such funds on terms acceptable to the Company.
QUARTERLY FLUCTUATIONS
The Company's quarterly revenues and operating results have varied
significantly in the past and are likely to vary substantially from quarter to
quarter in the future. The Company's operating results may fluctuate as a result
of a number of factors, including, but not limited to, increased expenses
(especially as they relate to product development and sales and marketing),
timing of product releases, increased competition, variations in the mix of
revenues, announcements of new products by the Company or its competitors and
capital spending patterns of the Company's customers. The Company establishes
its expenditure levels based upon its expectations as to future revenues, and,
if revenue levels are below expectations, expenses can be disproportionately
high. A drop in near term demand for the Company's products could significantly
affect both revenues and profits in any quarter. Operating results achieved in
previous fiscal quarters are not necessarily indicative of operating results for
the full fiscal years or for any future periods. As a result of these factors,
there can be no assurance that the Company will be able to establish or, when
established, maintain profitability on a quarterly basis. The Company believes
that,
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due to the underlying factors for quarterly fluctuations, period-to-period
comparisons of its operations are not necessarily meaningful and that such
comparisons should not be relied upon as indications of future performance.
FORWARD-LOOKING STATEMENTS
The foregoing Management's Discussion and Analysis of Financial
Condition and Results of Operations contains certain forward-looking statements
within the meaning of Section 27A of the Securities Act of 1933, as amended, and
Section 21E of the Securities Exchange Act of 1934, as amended. These
forward-looking statements represent the Company's expectations or beliefs,
including, but not limited to, statements concerning the Company's operations
and financial performance and condition. Words such as "anticipates," "expects,"
"intends," "plans," "believes," "seeks," "estimates," and similar expressions
are intended to identify such forward-looking statements. These forward-looking
statements are not guarantees of future performance and are subject to certain
risks and uncertainties that are difficult to predict. The Company's actual
results could differ materially from those contained in the forward-looking
statements. Factors that may cause such differences include, but are not limited
to, those discussed in the foregoing Management's Discussion and Analysis of
Financial Condition and Results of Operations as well as those discussed in the
Company's Form 10-K, including Exhibit 99.1 thereto. The Company undertakes no
obligation to publicly update or revise any forward-looking statements, whether
as a result of new information, future events or otherwise.
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ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
In the ordinary course of its operations, the Company is exposed to
certain market risks, primarily interest rates. Uncertainties that are either
non-financial or non-quantifiable, such as political, economic, tax, other
regulatory or credit risks are not included in the following assessment of the
Company's market risks.
Interest rates. Cash equivalents consist of money market accounts with
original maturities of less than three months. Interest on the Credit Facility,
as amended, which expires on May 28, 2004, is based on Prime Rate plus 1.0% per
annum. As of March 31, 2003, $1.2 million was outstanding under the Credit
Facility and the interest rate was 5.75% per annum. Changes in interest rates
could impact the Company's anticipated interest income from interest-bearing
cash accounts, or cash equivalents, as well as interest expense on current and
future borrowings under the Credit Facility.
ITEM 4. CONTROLS AND PROCEDURES
(a) Evaluation of disclosure controls and procedures. Within the 90
days prior to the filing date of this report, the Company carried out an
evaluation, under the supervision and with the participation of the Company's
management, including the Chief Executive Officer (the "CEO") and the Chief
Financial Officer (the "CFO"), of the effectiveness of the design and operation
of our disclosure controls and procedures pursuant to Securities Exchange Act of
1934 Rule 13a-15. Based on that evaluation, the Company's management, including
the CEO and CFO, concluded that the Company's disclosure controls and procedures
are effective in timely alerting them to material information required to be
included in the Company's periodic SEC reports. In addition, there have been no
significant changes in the Company's internal controls or in other factors that
could significantly affect those controls subsequent to the date of their
evaluation, including any corrective actions with respect to significant
deficiencies or material weaknesses. It should be noted that the design of any
system of controls is based in part upon certain assumptions about the
likelihood of future events, and there can be no assurance that any design will
succeed in achieving its stated goals under all potential future conditions,
regardless of how remote.
(b) Changes in internal controls. There have been no significant
changes in internal controls or other factors that could significantly affect
our internal controls subsequent to the date of such evaluation.
PART II -- OTHER INFORMATION
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
(c) Unregistered shares sold by the Company. During the three months
ended March 31, 2003, the Company raised an aggregate of $3.2 million of
additional capital through the private sales of 800,000 shares of the Company's
common stock and warrants to purchase 80,000 shares of the Company's common
stock at $4.00 per share to "accredited investors" as defined in Rule 501(a)
under the Securities Act of 1933, as amended (the "Securities Act").
All of the shares of common stock and warrants sold during the three
months ended March 31, 2003 were sold in private sales pursuant to Section 4(2)
of the Securities Act. The Company did not offer or sell the securities by any
form of general solicitation or general advertising. An underwriter was not
used. The Company received representations from each of the purchasers in
connection with the sale of securities, including that (i) such purchaser is an
"accredited investor", (ii) such purchaser has the appropriate business or
financial experience, (iii) such purchaser is able to bear the economic risk of
such investment and (iv) such purchaser is purchasing the securities for its own
account for investment purposes only and not with a view to or for distributing
or reselling such securities.
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The warrants have an exercise price of $4.00 per share, are fully
vested and exercisable and expire four years after the date of issuance. In the
event of a reorganization, recapitalization, stock split, stock dividend,
merger, sale of all or substantially all assets or other change in our corporate
structure or shares, our Board of Directors is required to change the number and
kind of shares (including by substituting shares of another corporation) subject
to the warrants and/or the exercise price of the warrants in the manner that our
Board of Directors reasonably deems equitable and appropriate.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
NUMBER DESCRIPTION
------ -----------
10.10 Fourth Loan Modification Agreement dated April 29, 2003 by and between
the Company and Silicon Valley Bank
31.1 Certification Pursuant to Rule 13a-14(a) and Rule 15d-14(a) of the
Securities Exchange Act of 1934, as amended*
31.2 Certification Pursuant to Rule 13a-14(a) and Rule 15d-14(a) of the
Securities Exchange Act of 1934, as amended*
32.1 Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant
to Section 906 of the Sarbanes-Oxley Act of 2002*
32.2 Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant
to Section 906 of the Sarbanes-Oxley Act of 2002*
*Filed herewith.
(b) Reports on Form 8-K
No report on Form 8-K was filed with the SEC during
the quarter ended March 31, 2003.
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934,
the Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
THE ULTIMATE SOFTWARE GROUP, INC.
Date: December 1, 2003 By: /s/ Mitchell K. Dauerman
-------------------------------------
Mitchell K. Dauerman
Executive Vice President, Chief Financial
Officer and Treasurer (Authorized Signatory
and Principal Financial and Accounting
Officer)
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