10-Q 1 ulti9302018q3.htm 10-Q Document


UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2018

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 incorporation
 
(I.R.S. Employer Identification No.)
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   No ☐
Indicate by check mark whether the registrant has submitted electronically, every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).  Yes   No ☐
Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company or an emerging growth company.  See definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and "emerging growth company" in Rule 12b-2 of the Exchange Act.
Large accelerated filer
 
 
Accelerated filer
 
Non-accelerated filer
 
 
Smaller reporting company
 
 
 
 
 
Emerging growth company
 
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or reviews financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ☐ No
As of November 1, 2018, there were 31,269,344 shares of the registrant’s common stock, par value $0.01, outstanding.




THE ULTIMATE SOFTWARE GROUP, INC. AND SUBSIDIARIES
TABLE OF CONTENTS
 
Page
 
 
 
Certifications
 


i



PART 1 – FINANCIAL INFORMATION
ITEM 1.
Financial Statements
THE ULTIMATE SOFTWARE GROUP, INC. AND SUBSIDIARIES
UNAUDITED CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands, except share data)
 
As of
 
As of
 
September 30, 2018
 
December 31, 2017
ASSETS
 
 
 
Current assets:
 
 
 
Cash and cash equivalents
$
132,723

 
$
155,685

Investments in marketable securities
8,232

 
9,434

Accounts receivable, net of allowance for doubtful accounts of $1,400 for 2018 and $900 for 2017
210,867

 
190,989

Deferred contract costs, prepaid expenses and other current assets
83,588

 
71,602

Total current assets before funds held for customers
435,410

 
427,710

Funds held for customers
567,208

 
563,062

Total current assets
1,002,618

 
990,772

Property and equipment, net
290,192

 
243,664

Goodwill
223,198

 
35,808

Intangible assets, net
151,247

 
20,862

Deferred contract costs and other assets, net
121,782

 
53,409

Deferred tax assets, net
21,556

 
32,696

Total assets
$
1,810,593

 
$
1,377,211

LIABILITIES AND STOCKHOLDERS’ EQUITY
 

 
 

Current liabilities:
 

 
 

Accounts payable
$
12,107

 
$
16,099

Accrued expenses and other liabilities
150,095

 
60,394

Deferred revenue
223,382

 
197,088

Capital lease obligations
6,420

 
5,474

Total current liabilities before customer funds obligations
392,004

 
279,055

Customer funds obligations
568,545

 
564,031

Total current liabilities
960,549

 
843,086

Deferred revenue
1,213

 
1,773

Deferred rent
8,778

 
5,349

Capital lease obligations
5,954

 
4,477

Other long-term liabilities
625

 
4,250

Deferred income tax liability
25,230

 
251

Total liabilities
1,002,349

 
859,186

Stockholders’ equity:
 

 
 

Series A Junior Participating Preferred Stock, $.01 par value, 500,000 shares authorized, no shares issued or outstanding

 

Preferred Stock, $.01 par value, 2,000,000 shares authorized, no shares issued or outstanding

 

Common Stock, $.01 par value, 50,000,000 shares authorized, 35,923,224 and 34,787,986 shares issued as of September 30, 2018 and December 31, 2017, respectively
359

 
348

Additional paid-in capital
834,846

 
609,160

Accumulated other comprehensive loss
(9,208
)
 
(5,912
)
Accumulated earnings
193,606

 
125,788

 
1,019,603

 
729,384

Treasury stock, 4,657,995 shares, at cost, for 2018 and 2017
(211,359
)
 
(211,359
)
Total stockholders’ equity
808,244

 
518,025

Total liabilities and stockholders’ equity
$
1,810,593

 
$
1,377,211


The accompanying Notes to Unaudited Condensed Consolidated Financial Statements are an integral part of these financial statements.

1



THE ULTIMATE SOFTWARE GROUP, INC. AND SUBSIDIARIES
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(In thousands, except per share amounts)
 
 
For the Three Months Ended September 30,
 
For the Nine Months Ended September 30,
 
2018
 
2017
 
2018
 
2017
Revenues:
 
 
 
 
 
 
 
Recurring
$
254,580

 
$
203,059

 
$
730,625

 
$
588,187

Services
33,247

 
33,054

 
105,119

 
101,109

Total revenues
287,827

 
236,113

 
835,744

 
689,296

Cost of revenues:
 

 
 

 
 
 
 
Recurring
71,243

 
52,558

 
200,731

 
155,166

Services
40,571

 
36,136

 
118,428

 
107,482

Total cost of revenues
111,814

 
88,694

 
319,159

 
262,648

Gross profit
176,013

 
147,419

 
516,585

 
426,648

Operating expenses:
 

 
 

 
 

 
 

Sales and marketing
72,077

 
65,066

 
209,481

 
201,441

Research and development
51,163

 
38,415

 
148,141

 
109,570

General and administrative
37,261

 
29,459

 
101,253

 
91,135

Total operating expenses
160,501

 
132,940

 
458,875

 
402,146

Operating income
15,512

 
14,479

 
57,710

 
24,502

Other income (expense):
 

 
 

 
 

 
 

Interest expense and other, net
(268
)
 
(239
)
 
(565
)
 
(684
)
Other income, net
1,353

 
57

 
2,532

 
364

Total other income (expense), net
1,085

 
(182
)
 
1,967

 
(320
)
Income before income taxes
16,597

 
14,297

 
59,677

 
24,182

Income tax benefit (provision)
488

 
(9,954
)
 
(7,918
)
 
(8,070
)
Net income
$
17,085

 
$
4,343

 
$
51,759

 
$
16,112

Net income per share:
 

 
 

 
 
 
 
Basic
$
0.55

 
$
0.15

 
$
1.69

 
$
0.54

Diluted
$
0.54

 
$
0.14

 
$
1.65

 
$
0.52

Weighted average shares outstanding:
 

 
 

 
 

 
 

Basic
31,077

 
29,848

 
30,703

 
29,713

Diluted
31,775

 
30,770

 
31,409

 
30,727

 
The accompanying Notes to Unaudited Condensed Consolidated Financial Statements are an integral part of these financial statements.

2



THE ULTIMATE SOFTWARE GROUP, INC. AND SUBSIDIARIES
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(In thousands)

 
For the Three Months Ended September 30,
 
For the Nine Months Ended September 30,
 
2018
 
2017
 
2018
 
2017
Net income
$
17,085

 
$
4,343

 
$
51,759

 
$
16,112

Other comprehensive income (loss):
 
 
 

 
 
 
 
Unrealized gain (loss) on investments in marketable available-for-sale securities
96

 
62

 
(136
)
 
(262
)
Unrealized (loss) gain on foreign currency translation adjustments
(2,252
)
 
892

 
(3,214
)
 
1,499

Other comprehensive (loss) income, before tax 
(2,156
)
 
954

 
(3,350
)
 
1,237

Income tax (provision) benefit related to items of other comprehensive income
(38
)
 
(25
)
 
54

 
104

Other comprehensive (loss) income, net of tax
$
(2,194
)
 
$
929

 
$
(3,296
)
 
$
1,341

Comprehensive income
$
14,891

 
$
5,272

 
$
48,463

 
$
17,453


The accompanying Notes to Unaudited Condensed Consolidated Financial Statements are an integral part of these financial statements.


3



THE ULTIMATE SOFTWARE GROUP, INC. AND SUBSIDIARIES
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
 
For the Nine Months Ended September 30,
 
2018
 
2017
Cash flows from operating activities:
 
 
 
Net income
$
51,759

 
$
16,112

Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 
Depreciation and amortization
34,575

 
25,068

Provision for doubtful accounts
6,344

 
4,525

Non-cash stock-based compensation expense
104,056

 
111,158

Income taxes
5,957

 
7,233

Net amortization of premiums and accretion of discounts on available-for-sale securities
(484
)
 
286

Changes in operating assets and liabilities, net of business combinations:
 
 
 
Accounts receivable
(18,584
)
 
(26,163
)
Deferred contract costs, prepaid expenses and other current assets
(30,245
)
 
(10,436
)
Deferred contract costs and other assets
(20,104
)
 
(3,819
)
Accounts payable
(9,125
)
 
(670
)
Accrued expenses, other liabilities and deferred rent
31,040

 
1,635

Deferred revenue
16,986

 
14,398

Net cash provided by operating activities
172,175

 
139,327

Cash flows from investing activities:
 

 
 

Purchases of property and equipment
(59,189
)
 
(62,010
)
Payments for acquisitions, net
(74,420
)
 

Purchases of marketable securities
(204,387
)
 
(152,041
)
Proceeds from sales and maturities of marketable securities
130,903

 
103,130

Net change in money market securities and other cash equivalents held to satisfy customer funds obligations
70,890

 
47,451

Net cash used in investing activities
(136,203
)
 
(63,470
)
Cash flows from financing activities:
 

 
 

Net proceeds from issuances of Common Stock
3,263

 
5,038

Shares acquired to settle employee tax withholding liabilities
(55,707
)
 
(37,258
)
Principal payments on capital lease obligations
(5,090
)
 
(4,713
)
Payments of other long-term liabilities
(3,626
)
 

Net change in customer funds obligations
4,515

 
12,198

Net cash used in financing activities
(56,645
)
 
(24,735
)
Effect of exchange rate changes on cash
(2,289
)
 
817

Net (decrease) increase in cash and cash equivalents
(22,962
)
 
51,939

Cash and cash equivalents, beginning of period
155,685

 
73,773

Cash and cash equivalents, end of period
$
132,723

 
$
125,712

 
 
 
 
Supplemental disclosure of cash flow information:
 

 
 

Cash paid for interest
$
436

 
$
374

Cash paid for taxes
$
6,030

 
$
1,693

 
 

 
 

Non-cash investing and financing activities:
 
 
 
Stock consideration recorded for business combination
$
171,947

 
 
Deferred cash consideration for business combination
$
50,000

 
$

Capital lease obligations to acquire new equipment
$
7,512

 
$
5,033

Stock based compensation for capitalized software
$
2,643

 
$
3,021

Software agreement
$

 
$
6,500

The accompanying Notes to Unaudited Condensed Consolidated Financial Statements are an integral part of these financial statements.

4



THE ULTIMATE SOFTWARE GROUP, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

1.
Nature of Operations
The Ultimate Software Group, Inc. and subsidiaries (“Ultimate,” “we,” “us” or “our”) is a leading provider of cloud-based human capital management solutions, often referred to as human capital management (“HCM”). Ultimate's UltiPro product suite (“UltiPro”) is a comprehensive, engaging solution that has human resources ("HR"), payroll, and benefits management at its core and includes global people management, available in 14 languages with more than 37 country-specific localizations. The solution is delivered via software-as-a-service ("SaaS"), now more commonly known as the cloud computing model, to organizations based in the United States and Canada, including those with global workforces. UltiPro is designed to deliver the functionality businesses need to manage the complete employment life cycle from recruitment to retirement. We market our UltiPro solutions primarily to enterprise companies, which we define as organizations with 2,501 or more employees, including those with 10,000 or more employees; mid-market companies, which we define as those having 501-2,500 employees; and strategic market companies, which we define as those having 100-500 employees. UltiPro is marketed primarily through our enterprise, mid-market and strategic direct sales teams.

2.
Basis of Presentation, Consolidation and the Use of Estimates
The accompanying unaudited condensed consolidated financial statements of Ultimate 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 prepared in accordance with U.S. generally accepted accounting principles (“GAAP”) have been condensed or omitted pursuant to such rules and regulations. The information in this quarterly report should be read in conjunction with Ultimate’s audited consolidated financial statements and notes thereto included in Ultimate’s Annual Report on Form 10-K for the fiscal year ended December 31, 2017 filed with the SEC on February 26, 2018 (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 Ultimate’s management, necessary for a fair presentation of the information for the periods presented. The preparation of financial statements in conformity with 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. Interim results of operations for the three and nine months ended September 30, 2018 are not necessarily indicative of operating results for the full fiscal year or for any future periods.
The unaudited condensed consolidated financial statements reflect the financial position and operating results of Ultimate and include its wholly-owned subsidiaries. Intercompany accounts and transactions have been eliminated in consolidation.
3.
Accounting Standards and Significant Accounting Policies
Recently Adopted Accounting Standards
In April 2018, we adopted Accounting Standards Update ("ASU") No. 2018-02, "Income Statement-Reporting Comprehensive Income (Topic 220): Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income," ("ASU 2018-02"). ASU 2018-02 allows companies to reclassify stranded tax effects resulting from the Tax Cuts and Jobs Act (the “Tax Act”) from accumulated other comprehensive income to retained earnings. The unaudited condensed consolidated balance sheets reflect the reclassification out of accumulated other comprehensive income. The Company's policy for releasing disproportionate income tax effects from accumulated other comprehensive income utilizes the aggregate approach. The adoption of ASU 2018-02 did not have an impact on the our unaudited condensed consolidated statements of income or cash flows.

In May 2014, the Financial Accounting Standards Board ("FASB") issued ASU No. 2014-09, “Revenue from Contracts with Customers (Topic 606)” (“Topic 606”). Topic 606 supersedes the revenue requirements in ASU Topic 605, Revenue Recognition ("Topic 605") and requires the recognition of revenues when promised goods or services are transferred to customers in an amount that reflects the consideration that is expected to be received for those goods or services and includes Subtopic 340-40, Other Assets and Deferred Costs - Contracts with Customers, which discusses the deferral of incremental costs of obtaining a contract with a customer, including the period of amortization of such costs. In addition, the standard requires disclosure of the nature, amount, timing, and uncertainty of revenues and cash flows arising from contracts with customers. Collectively, we refer to Topic 606 and Subtopic 340-40 as the "new standard."

5




Effective January 1, 2018, we adopted the requirements of the new standard, utilizing the modified retrospective method of transition with the new standard applied to all customer contracts that were not completed on the effective date of the new standard. Adoption of the new standard resulted in changes to our accounting policies for revenue recognition, as detailed below.

The impact of adopting the new standard on our revenues resulted in an immaterial increase to deferred revenue and had a material impact on our unaudited condensed consolidated balance sheet, as a result of the amortization period over which deferred contract costs to obtain related subscription contracts are recognized. Under Topic 605, we deferred incremental commission costs to obtain a contract and amortized those costs over the initial term of the related subscription contract, which is generally 2-3 years. During our assessment of the new standard, we did not identify any incremental contract costs from what was capitalized under Topic 605. We analyzed our customer contract term periods and our customer life, taking into consideration technological changes for our UltiPro product offering, and based, on our assessment of the new standard, we amortize the deferred contract costs over 7 years on a systematic basis, consistent with the pattern of transfer of the goods or services to which the asset relates. Ultimate does not pay sales commissions for subscription contracts beyond the initial term of the contract; therefore, there are no renewal commissions incurred for contracts in their renewal periods.

The cumulative effect of the changes made to our January 1, 2018 balance sheet for the adoption of the new standard were as follows (in thousands):
 
 
Balance as of December 31, 2017
 
Adjustments Due to Adoption of Topic 606
 
Balance as of January 1, 2018
Assets
 
 
 
 
 
 
Deferred contract costs, prepaid expenses and other current assets
 
$
71,602

 
$
(22,318
)
 
$
49,284

Total current assets
 
990,772

 
(22,318
)
 
968,454

Deferred contract costs and other assets, net
 
53,409

 
47,259

 
100,668

Deferred tax assets, net
 
32,696

 
(6,803
)
 
25,893

Total assets
 
$
1,377,211

 
$
18,138

 
$
1,395,349

Liabilities
 
 
 
 
 
 
Deferred revenue
 
$
197,088

 
$
1,909

 
$
198,997

Total current liabilities
 
843,086

 
1,909

 
844,995

Deferred income tax liability
 
251

 
170

 
422

Total liabilities
 
859,186

 
2,079

 
861,265

Stockholders' Equity
 
 
 
 
 
 
Accumulated earnings
 
125,788

 
16,059

 
141,847

Total stockholders' equity
 
518,025

 
16,059

 
534,084

Total liabilities and stockholders' equity
 
$
1,377,211

 
$
18,138

 
$
1,395,349


In accordance with the requirements of the new standard, the disclosure for the quantitative effect and the significant changes between the reported results under the new standard and those that would have been reported under legacy GAAP (i.e., Topic 605) on our unaudited consolidated condensed income statement and balance sheet was as follows (in thousands):


6



 
 
For the Three Months Ended September 30, 2018
 
For the Nine Months Ended September 30, 2018
 
 
As Reported - Topic 606
 
Balances Without Adoption of Topic 606
 
Effect of Change Higher/(Lower)
 
As Reported - Topic 606
 
Balances Without Adoption of Topic 606
 
Effect of Change Higher/(Lower)
Income Statement
 
 
 
 
 
 
 
 
 
 
 
 
Revenues
 
 
 
 
 
 
 
 
 
 
 
 
Recurring revenues
 
$
254,580

 
$
254,792

 
$
(212
)
 
$
730,625

 
$
731,597

 
$
(972
)
 
 

 

 

 
 
 
 
 
 
Operating Expenses
 
 
 
 
 
 
 
 
 
 
 
 
Sales and marketing
 
72,077

 
77,352

 
(5,275
)
 
209,481

 
225,831

 
(16,350
)
 
 
 
 
 
 
 
 
 
 
 
 
 
Net income
 
$
17,085

 
$
12,023

 
$
5,062

 
$
51,759

 
$
41,656

 
$
10,103

 
 
As of September 30, 2018
 
 
As Reported - Topic 606
 
Balances Without Adoption of Topic 606
 
Effect of Change Higher/(Lower)
Balance Sheet
 
 
 
 
 
 
Assets
 
 
 
 
 
 
Deferred contract costs, prepaid expenses and other current assets
 
$
83,588

 
$
104,430

 
$
20,842

Deferred contract costs and other assets, net
 
121,782

 
$
59,648

 
(62,134
)
Liabilities
 
 
 
 
 
 
Deferred revenue
 
223,382

 
220,384

 
2,998

Stockholders' Equity
 
 
 
 
 
 
Accumulated earnings
 
193,606

 
237,896

 
(44,290
)
In March 2018, the FASB issued ASU 2018-05, “Income Taxes (Topic 740): Amendments to SEC Paragraphs Pursuant to SEC Staff Accounting Bulletin No. 118,” ("SAB 118"). The ASU amends Topic 740 to incorporate SEC guidance issued in its SAB 118. SAB 118 addressed the application of generally accepted accounting principles in situations when a registrant does not have the necessary information available, prepared or analyzed (including computations) in reasonable detail to complete the accounting for certain income tax effects of the Tax Cuts and Jobs Act. The amendments in this update were effective upon issuance, at which time Ultimate adopted the standard. Adoption of this standard did not have a material impact on our financial condition or results of operations.

Summary of Significant Accounting Policies
Except for the accounting policy for revenue recognition that was updated as a result of adopting Topic 606, there have been no changes to our significant accounting policies described in the Annual Report on Form 10-K for the year ended December 31, 2017, filed with the SEC on February 26, 2018, that have had a material impact on our unaudited condensed consolidated financial statements and related notes.
Revenue Recognition
Effective January 1, 2018, we recognize revenues in accordance with Topic 606. The core principle of Topic 606 is that revenue is recognized upon transfer of control of promised products or services to customers in an amount that reflects the consideration we expect to receive in exchange for those products or services. To achieve the core principle of Topic 606, we perform the following steps:

7



1)    Identify the contract(s) with a customer;
2)    Identify the performance obligations in the contract;
3)    Determine the transaction price;
4)    Allocate the transaction price to the performance obligations in the contract; and
5)    Recognize revenue when (or as) we satisfy a performance obligation.

The significant majority of our two major revenue sources, recurring and services, is derived from contracts with customers. Recurring revenues are primarily related to our subscription-based SaaS performance obligations. Services revenues are primarily related to implementation services for our SaaS customers (including activation services typically billed on a time and materials basis) and, to a much lesser extent, fees for other services, including the provision of payroll-related forms, sales of time clocks and the printing of W-2 and Affordable Care Act ("ACA") forms for certain customers, as well as certain client reimbursable out-of-pocket expenses ("Other Services"). Fees charged to subscription-based SaaS performance obligations are each priced on a per-employee-per-month (“PEPM”) basis for a given calendar month based on usage, and fees charged for implementation services are typically priced on a fixed fee basis for activating the product offering. Our SaaS subscription revenues are satisfied over time, because they are simultaneously received and consumed by the customer. Our activation services revenues are satisfied over time because they are simultaneously received and consumed by the customer.

Our SaaS performance obligations are each priced based on the number of active customer employees, as of the signing of the contract, at the contract PEPM rate over the initial contract term. Our activation services are based on a fixed fee charged to our customers. There is typically no variable consideration related to our SaaS performance obligations or our activation services, nor do they include a significant financing component, non-cash consideration, or consideration payable to a customer. Our SaaS performance obligations are typically billed quarterly in advance while our activation services are billed over the implementation period.
Our SaaS arrangements include multiple performance obligations and transaction price allocations are based on the stand-alone selling price ("SSP") for each performance obligation. There is an observable input for SSP for each of the SaaS performance obligations. Since activation services do not have directly observable pricing, the SSP is estimated using market conditions and observable inputs, which is calculated based on historical average discounts off our standard price list.
For our performance obligations, the consideration allocated to cloud subscription revenues is recognized as recurring revenues, typically using the output method, over the initial contract period, as those subscription-based services are consumed, typically commencing with the date the customer processes their first live payroll using UltiPro (referred to as going "Live"). The consideration allocated to activation services is recognized as services revenues based on the proportion performed, using reasonably dependable estimates (in relation to progression through activation phases), by product. Activation services are performed by our implementation consultants and, to a lesser extent, third party implementation partners. For activation services performed by third party implementation partners, we act as the principal and report revenues on a gross basis, meaning the amounts billed to customers are recorded as services revenues, and related expenses incurred are recorded as cost of services revenues. We control the activation services performed by third party implementation partners and act as principal because we are ultimately responsible to our customers and have full discretion in establishing prices.
Customers enter into contracts for services billed on a time and materials basis and Other Services. Time and materials services are satisfied over time because the customer simultaneously receives and consumes the benefit as we perform. Services revenues for time and materials work are recognized in the period performed. Fees from Other Services substantially include the provision of payroll-related forms, sales of time clocks and printing services for certain customers. For these Other Services, revenue is recognized at a point in time, upon shipment which is when control of the goods and services transfers to the customer.

Recently Issued Accounting Standards
In February 2016, the FASB issued ASU 2016-02, "Leases" ("ASU 2016-02"), to increase transparency and comparability among organizations by recognizing lease assets and lease liabilities on the balance sheet and disclosing key information about leasing arrangements. The new standard is effective for Ultimate on January 1, 2019 and early adoption is permitted.  We expect to adopt the new standard on its effective date and are evaluating the modified retrospective methods that allow the initial application of the new standard either on effective date or the beginning of the earliest comparative period presented in the financial statements in the period of adoption. The Company is reviewing its existing leases and expects an impact to the assets and liabilities on our consolidated balance sheet as a result of recognizing right-of-use assets and lease liabilities for operating lease contracts that exist on the date of initial application of the new guidance. The total impact is still being estimated as we continue to review its lease portfolio.

8




4.    Business Combination
Acquisition of PeopleDoc SAS
On July 26, 2018, Ultimate, PeopleDoc SAS, a simplified joint-stock company (société par actions simplifiée) organized under the laws of France (“PeopleDoc”) and certain shareholders of PeopleDoc, entered into a Share Purchase Agreement (the “Purchase Agreement”) and on July 27, 2018, the parties consummated the transactions contemplated by the Purchase Agreement and Ultimate acquired PeopleDoc. PeopleDoc, a pioneer in HR Service Delivery, is based in Paris, France and has more than 1,000 customers with users in 180 countries. The addition of the PeopleDoc HR Service Delivery platform will further Ultimate's mission to improve the employee experience by offering new, person-centric features, such as an online employee help center, HR case management, and employee file management.
Pursuant to the Purchase Agreement, Ultimate acquired all of the capital stock of PeopleDoc for aggregate consideration valued at $296.4 million, subject to post-closing adjustments, paid with a combination of cash and shares of Ultimate common stock.
The following table summarizes the calculation of consideration transferred and deferred under the transaction (in thousands of USD):
 
Note
 
Amount
Calculation of consideration
 
 
 
Cash consideration:
 
 
 
Cash paid to PeopleDoc shareholders
(a)
 
$
74,420

Deferred cash consideration
(b)
 
50,000

Actual cash consideration
 
 
$
124,420

Share consideration:
 
 
 
Share consideration paid to PeopleDoc shareholders
(c)
 
$
172,806

Marketability of deferred stock consideration
(d)
 
$
(859
)
Actual share consideration
 
 
171,947

Fair value of total consideration transferred
 
 
$
296,367

 
 
 
 
(a) Initial cash consideration paid to PeopleDoc shareholders per the Purchase Agreement at the closing of the transaction.
(b) Deferred cash consideration to be paid on the first anniversary of the closing date of the transaction.
(c) Share consideration paid to PeopleDoc shareholders per the Purchase Agreement at the time of closing the transaction. Share consideration paid to PeopleDoc shareholders consists of 595,445 shares at the closing stock price of $282.74 in addition to a restricted stock award with an intrinsic value of $4.5 million at the acquisition date.
(d) Reflects a marketability adjustment to the deferred stock consideration.
    
Under ASC 805, generally all assets acquired and liabilities assumed are recorded at their acquisition date fair value. The unaudited condensed consolidated financial statements include various assumptions related to the preliminary purchase price allocation of the assets acquired and liabilities assumed of PeopleDoc based on management's best estimates of fair value.
The purchase price allocation for the PeopleDoc acquisition is substantially complete and has been allocated based on estimated fair values of the assets acquired and liabilities assumed at the acquisition date, subject to any changes to facts and circumstances during the measurement period. Although the purchase price allocation is substantially complete, the purchase price allocation disclosed could change and adjustments can be made through the end of Ultimate’s measurement period, which is not to exceed one year from the acquisition date. The following table represents the allocation of the purchase price for PeopleDoc to the acquired identifiable assets, assumed liabilities and goodwill (in thousands of USD):

9



Description
Note
Amount
Current assets
(a)
$
15,581

Property and equipment, net
(a)
1,489

Other non-current assets
(a)
1,010

Identifiable intangible assets
(b)
136,800

Goodwill
(c)
189,206

Total current liabilities
(a), (d)
(14,713
)
Deferred revenue
(a)
(6,900
)
Deferred tax liability, net
(e)
(26,106
)
Total purchase price
 
$
296,367

 
 
 
(a) Represents fair value of assets and liabilities assumed as part of the transaction based on the closing balance sheet provided by PeopleDoc.
(b) Fair value of intangible assets based on preliminary valuation. Identifiable intangible assets consisted primarily of developed technology of $77.0 million estimated using the relief from royalty method.
(c) Goodwill represents the excess of the preliminary purchase price over the preliminary fair value of the underlying net tangible and intangible assets acquired and liabilities assumed. Goodwill recorded is attributable to the expected synergies to be realized when combining the operations of this entity into our existing operations. Goodwill from this transaction is not deductible for tax purposes.
(d) Included in total current liabilities was debt assumed of $4.8 million as of the closing of the transaction. As of September 30, 2018, the debt assumed was $4.1 million and is included in accrued expenses and other liabilities on our unaudited condensed consolidated balance sheets. The debt assumed will mature starting January 16, 2019 through July 31, 2022 and has interest rates ranging from 0.5% to 3.0%.
(e) Reflects the recognition of a deferred tax asset and deferred tax liability as of the acquisition date for the taxable and deductible temporary differences between the financial reporting values of assets acquired and liabilities assumed and the tax bases of those assets and liabilities.
The results of operations from this acquisition have been included in our unaudited condensed consolidated financial statements since the closing of the PeopleDoc acquisition. Pro forma results of operations were presented on Form 8-K/A filed with the SEC on October 10, 2018. The transaction costs associated with this acquisition for the three and nine months ended September 30, 2018, were approximately $1.8 million and $3.0 million, respectively, and were recorded in general and administrative expense.

5.    Funds held for Customers, Corporate Investments in Marketable Securities and Fair Value of Financial Instruments
We classify our investments in marketable securities with readily determinable fair values as available-for-sale. Available-for-sale securities consist of debt and equity securities not classified as trading securities or as securities to be held to maturity. Unrealized gains and losses, net of tax, on available-for-sale securities are reported as a net amount in accumulated other comprehensive income in stockholders’ equity until realized. Realized gains and losses resulting from available-for-sale securities are included in other income, net, in the unaudited condensed consolidated statements of income. There were no significant reclassifications of realized gains and losses on available-for-sale securities to the unaudited condensed consolidated statements of income for the three and nine months ended September 30, 2018 and September 30, 2017.
Gains and losses on the sale of available-for-sale securities are determined using the specific identification method.   There was $753 thousand and $704 thousand of net unrealized loss on available-for-sale securities as of September 30, 2018 and December 31, 2017, respectively.
The amortized cost, net unrealized loss and fair value of our funds held for customers and corporate investments in marketable available-for-sale securities as of September 30, 2018 and December 31, 2017 are shown below (in thousands):

10



 
As of September 30, 2018
 
As of December 31, 2017
 
Amortized Cost
 
Net Unrealized (Loss)/Gain
 
Fair Value (1)
 
Amortized Cost
 
Net Unrealized (Loss)/Gain
 
Fair Value (1)
Type of issue:
 
 
 
 
 
 
 
 
 
 
 
Funds held for customers – money market securities and other cash equivalents
$
283,422

 
$

 
$
283,422

 
$
354,312

 
$

 
$
354,312

Available-for-sale securities:
 
 
 
 
 
 
 
 
 
 
 
Corporate debentures – bonds
2,209

 

 
2,209

 
2,848

 
(4
)
 
2,844

Commercial paper
3,180

 

 
3,180

 

 

 

U.S. Agency bonds
284,539

 
(753
)
 
283,786

 
209,443

 
(693
)
 
208,750

U.S. Treasury bills
1,495

 

 
1,495

 
5,876

 
(6
)
 
5,870

Asset-Backed securities
1,348

 

 
1,348

 
721

 
(1
)
 
720

Total corporate investments and funds held for customers
$
576,193

 
$
(753
)
 
$
575,440

 
$
573,200

 
$
(704
)
 
$
572,496

_________________
(1) Included within available-for-sale securities as of September 30, 2018 and December 31, 2017 are corporate investments with fair values of $8.2 million and $9.4 million, respectively. Included within available-for-sale securities as of September 30, 2018 and December 31, 2017 are funds held for customers with fair values of $283.8 million and $208.8 million, respectively. All available-for-sale securities were included in Level 2 of the fair value hierarchy.
The unrealized losses and fair values of available-for-sale securities that have been in an unrealized loss position for a period of less than and greater than 12 months as of September 30, 2018 are as follows (in thousands):
 
 
Securities in unrealized loss position less than 12 months
 
Securities in unrealized loss position greater than 12 months
 
Total
 
 
Gross unrealized losses
 
Fair market value
 
Gross unrealized losses
 
Fair market value
 
Gross unrealized losses
 
Fair market value
U.S. Agency bonds
 

 

 
(892
)
 
244,706

 
(892
)
 
244,706

Total
 
$

 
$

 
$
(892
)
 
$
244,706

 
$
(892
)
 
$
244,706

The unrealized losses and fair values of available-for-sale securities that have been in an unrealized loss position for a period of less than and greater than 12 months as of December 31, 2017 are as follows (in thousands):
 
 
Securities in unrealized loss position less than 12 months
 
Securities in unrealized loss position greater than 12 months
 
Total
 
 
Gross unrealized losses
 
Fair market value
 
Gross unrealized losses
 
Fair market value
 
Gross unrealized losses
 
Fair market value
Corporate debentures – bonds
 
$
(1
)
 
$
699

 
$

 
$

 
$
(1
)
 
$
699

U.S. Agency bonds
 
(408
)
 
74,940

 
(285
)
 
133,811

 
(693
)
 
208,751

U.S. Treasury bills
 

 

 
(6
)
 
5,869

 
(6
)
 
5,869

Total
 
$
(409
)
 
$
75,639

 
$
(291
)
 
$
139,680

 
$
(700
)
 
$
215,319

The amortized cost and fair value of the marketable available-for-sale securities, by contractual maturity, as of September 30, 2018, are shown below (in thousands):
 
 
Corporate Investments
 
Investments with Funds Held for Customers
 
Total
 
 
Amortized Cost
 
Fair Value
 
Amortized Cost
 
Fair Value
 
Amortized Cost
 
Fair Value
Due in one year or less
 
$
8,233

 
$
8,232

 
$
223,769

 
$
223,287

 
$
232,002

 
$
231,519

Due after one year
 

 

 
60,770

 
60,499

 
60,770

 
60,499

Total
 
$
8,233

 
$
8,232

 
$
284,539

 
$
283,786

 
$
292,772

 
$
292,018


11



The amortized cost and fair value of the marketable available-for-sale securities, by contractual maturity, as of December 31, 2017, are shown below (in thousands):
 
 
Corporate Investments
 
Investments with Funds Held for Customers
 
Total
 
 
Amortized Cost
 
Fair Value
 
Amortized Cost
 
Fair Value
 
Amortized Cost
 
Fair Value
Due in one year or less
 
$
9,445

 
$
9,434

 
$
164,072

 
$
163,641

 
$
173,517

 
$
173,075

Due after one year
 

 

 
45,371

 
45,109

 
45,371

 
45,109

Total
 
$
9,445

 
$
9,434

 
$
209,443

 
$
208,750

 
$
218,888

 
$
218,184

We classify and disclose fair value measurements in one of the following three categories of fair value hierarchy:
Level 1 -
Unadjusted quoted prices in active markets that are accessible at the measurement date for identical, unrestricted assets and liabilities.
Level 2 -
Quoted prices in markets that are not active or financial instruments for which all significant inputs are observable, either directly or indirectly.
Level 3 -
Prices or valuations that require inputs that are both significant to the fair value measurement and unobservable.
A financial instrument’s level within the fair value hierarchy is based on the lowest level of any input that is significant to the fair value measurement.
Our assets that are measured by management at fair value on a recurring basis are generally classified within Level 1 or Level 2 of the fair value hierarchy. We have had assets in the past, and may have assets in the future, classified within Level 1 of the fair value hierarchy. No assets or investments were classified within Level 1 of the fair value hierarchy as of September 30, 2018 or as of December 31, 2017. We did not have any transfers into and out of Level 1 or Level 2 during the three and nine months ended September 30, 2018 or the twelve months ended December 31, 2017. No assets or investments were classified as Level 3 as of September 30, 2018 or as of December 31, 2017.
The types of instruments valued by management, based on quoted prices in less active markets, broker or dealer quotations, or alternative pricing sources with reasonable levels of price transparency, include corporate debentures and bonds, commercial paper, U.S. agency bonds and U.S. Treasury bills and asset-backed securities owned by Ultimate. Such instruments are generally classified within Level 2 of the fair value hierarchy. Ultimate uses consensus pricing, which is based on multiple pricing sources, to value its fixed income investments. The following table sets forth, by level within the fair value hierarchy, financial assets accounted for at fair value as of September 30, 2018 and December 31, 2017 (in thousands):
 
As of September 30, 2018
 
As of December 31, 2017
 
Total
 
(Level 1)
 
(Level 2)
 
(Level 3)
 
Total
 
(Level 1)
 
(Level 2)
 
(Level 3)
Corporate debentures – bonds
$
2,209

 
$

 
$
2,209

 
$

 
$
2,844

 
$

 
$
2,844

 
$

Commercial paper
3,180

 

 
3,180

 

 

 

 

 

U.S. Agency bonds
283,786

 

 
283,786

 

 
208,750

 

 
208,750

 

U.S. Treasury bills
1,495

 

 
1,495

 

 
5,870

 

 
5,870

 

Asset-Backed securities
1,348

 

 
1,348

 

 
720

 

 
720

 

Total
$
292,018

 
$

 
$
292,018

 
$

 
$
218,184

 
$

 
$
218,184

 
$

Assets measured at fair value on a recurring basis were presented in the unaudited condensed consolidated balance sheet as of September 30, 2018 and the audited consolidated balance sheet as of December 31, 2017 as short-term and long-term investments in marketable securities. There were no financial liabilities accounted for at fair value as of September 30, 2018 and December 31, 2017.
6.
Property and Equipment
Property and equipment are stated at cost, net of accumulated depreciation and amortization. Property and equipment are depreciated using the straight-line method over the estimated useful lives of the assets, which range from 2 to 15 years. Leasehold improvements and assets under capital leases are amortized over the shorter of the estimated useful life of the asset or the term of the lease, which range from 3 to 15 years. Maintenance and repairs are charged to expense when incurred; betterments are capitalized. Upon the sale or retirement of assets, the cost, accumulated depreciation and amortization are removed from the accounts and any gain or loss is recognized.
Property and equipment as of September 30, 2018 and December 31, 2017 consist of the following (in thousands):
 
As of September 30, 2018
 
As of December 31, 2017
Computer equipment
$
205,965

 
$
185,034

Internal-use software
218,802

 
178,093

Leasehold improvements
52,350

 
43,556

Other property and equipment
25,512

 
22,572

Property and equipment
502,629

 
429,255

Less: accumulated depreciation and amortization
212,437

 
185,591

Property and equipment, net
$
290,192

 
$
243,664

We capitalize computer software development costs related to software developed for internal use in accordance with Accounting Standards Codification ("ASC") Topic 350-40, Intangibles Goodwill and Other-Internal Use Software. During the three and nine months ended September 30, 2018, we capitalized $12.3 million and $39.7 million, respectively, of computer software development costs related to a development project to be sold in the future as a cloud product only (the "Development Project"). There were $13.9 million and $40.1 million of software development costs related to the Development Project which were capitalized in the three and nine months ended September 30, 2017, respectively. For the three and nine months ended September 30, 2018 and September 30, 2017, these capitalized costs were primarily direct labor costs. As a component of these direct labor costs we capitalized $0.9 million and $2.6 million of stock-based compensation costs during the three and nine months ended September 30, 2018, respectively. During the three and nine months ended September 30, 2017, we capitalized $1.0 million and $3.0 million, respectively, of stock-based compensation costs. These capitalized costs are included with internal-use software in property and equipment in the unaudited condensed consolidated balance sheets and purchases of property and equipment in the unaudited condensed consolidated statements of cash flows. Internal-use software is amortized on a straight-line basis over its estimated useful life, commencing after the software development is substantially complete and the software is ready for its intended use. At each balance sheet date, we evaluate the useful lives of these assets and test for impairment whenever events or changes in circumstances occur that could impact the recoverability of these assets. During the three and nine months ended September 30, 2018 there were $2.8 million and $6.7 million, respectively, of amortization associated with certain product modules of the Development Project which were ready for their intended use. During the three and nine months ended September 30, 2017 there were $1.0 million and $3.1 million, respectively, of amortization associated with certain product modules of the Development Project which were ready for their intended use. The amortization of capitalized software is included in cost of recurring revenues.
7.
Deferred Contract Costs, Prepaid Expenses and Other Current Assets
Deferred contract costs, prepaid expenses and other current assets as of September 30, 2018 and December 31, 2017 consist of the following (in thousands):
 
As of September 30, 2018
 
As of December 31, 2017
Deferred contract costs
$
35,350

 
$
38,519

Prepaid expenses
30,607

 
20,088

Other current assets
17,631

 
12,995

Total deferred contract costs, prepaid expenses and other current assets
$
83,588

 
$
71,602

Deferred contract costs, which are primarily deferred sales commissions earned by our sales force and are considered incremental and recoverable costs of obtaining a contract with a customer, were $35.2 million as of September 30, 2018 and

12



$38.5 million as of December 31, 2017. Amortization expense for the deferred contract costs was $5.6 million and $16.5 million for the three and nine months ended September 30, 2018, respectively. Amortization expense for the deferred contract costs was $9.2 million and $27.5 million for the three and nine months ended September 30, 2017, respectively. There was no impairment loss in relation to the costs capitalized for the periods presented.

Included in deferred contract costs and other assets, net are deferred contract costs of $108.6 million as of September 30, 2018 and $45.5 million as of December 31, 2017. Deferred contract costs are primarily deferred sales commissions earned by our sales force and are considered incremental and recoverable costs of obtaining a contract with a customer. The amortization of these deferred contract costs will be recognized beyond the next twelve months.

8.
Goodwill and Intangible Assets
Goodwill
Goodwill represents the excess of cost over the net tangible and identifiable intangible assets of acquired businesses. Goodwill amounts are not amortized, but rather tested for impairment at least annually. Identifiable intangible assets acquired in business combinations are recorded based upon fair value at the date of acquisition and amortized over their estimated useful lives.
The changes in the carrying value of goodwill since December 31, 2017 were as follows (in thousands):
Goodwill, December 31, 2017
$
35,808

Goodwill from PeopleDoc acquisition (1)
189,206

Translation adjustment for the nine months ended September 30, 2018 (2)
(1,816
)
Goodwill, September 30, 2018
$
223,198

__________________________
(1) Represents the preliminary goodwill for the acquisition of PeopleDoc acquired on July 27, 2018.
(2) Represents the impact of the foreign currency translation of the portion of goodwill that is recorded by our foreign subsidiaries whose functional currency is also their respective local currencies. Such goodwill is translated into U.S. dollars using exchange rates in effect at period end. Adjustments related to foreign currency translation are included in other comprehensive (loss) income.

13



Intangible Assets
The following tables present our acquired intangible assets as of the dates specified below (in thousands):
 
September 30, 2018
 
Gross Carrying Amount
 
Accumulated Amortization
 
Cumulative Translation Adjustment (1)
 
Net Carrying Amount
 
Weighted Average Remaining Useful Life
Developed technology
$
100,300

 
$
(7,962
)
 
$
(1,569
)
 
$
90,769

 
6.6
Customer relationships
63,700

 
(3,622
)
 
(483
)
 
59,595

 
9.6
Trademark
800

 
(27
)
 
(6
)
 
767

 
4.8
Non-compete agreements
300

 
(300
)
 

 

 
0.0
 
$
165,100

 
$
(11,911
)
 
$
(2,058
)
 
$
151,131

 
7.8
 
 
 
 
 
 
 
 
 
 
 
December 31, 2017
 
Gross Carrying Amount
 
Accumulated Amortization
 
Cumulative Translation Adjustment (1)
 
Net Carrying Amount
 
Weighted Average Remaining Useful Life
Developed technology
$
23,300

 
$
(4,355
)
 
$
(895
)
 
$
18,050

 
6.0
Customer relationships
4,700

 
(2,004
)
 

 
2,696

 
4.5
Non-compete agreements
300

 
(300
)
 

 

 
0.0
 
$
28,300

 
$
(6,659
)
 
$
(895
)
 
$
20,746

 
5.9
____________________________
(1) Represents the impact of the foreign currency translation of the portion of acquired intangible assets that is recorded by our foregin subsidiaries whose functional currency is also their respective local currencies. Such intangible assets are translated into U.S. dollars using exchange rates in effect at period end. Adjustments related to foreign currency translation are included in other comprehensive (loss) income.
Acquired intangible assets are amortized over their estimated useful life, generally three to ten years, in a manner that reflects the pattern in which the economic benefits are consumed. Included in acquired intangible assets as of September 30, 2018 and December 31, 2017 were $0.1 million of assets with indefinite lives. Amortization expense for acquired intangible assets was $3.7 million and $5.3 million for the three and nine months ended September 30, 2018, respectively, and $0.8 million and $2.3 million for the three and nine months ended September 30, 2017, respectively.
9.
Earnings Per Share
Basic earnings per share is computed by dividing income available to common stockholders (the numerator) by the weighted average number of common shares outstanding (the denominator) for the period. The computation of diluted earnings per share is similar to basic earnings per share, except that the denominator is increased to include the number of additional common shares that would have been outstanding if the potentially dilutive common shares had been issued.

14



The following table is a reconciliation of the shares of Ultimate's issued and outstanding $0.01 par value common stock ("Common Stock") used in the computation of basic and diluted net income per share for the three and nine months ended September 30, 2018 and 2017 (in thousands):
 
For the Three Months Ended September 30,
 
For the Nine Months Ended September 30,
 
2018
 
2017
 
2018
 
2017
Basic weighted average shares outstanding
31,077

 
29,848

 
30,703

 
29,713

Effect of dilutive equity instruments
698

 
922

 
706

 
1,014

Diluted weighted average shares outstanding
31,775

 
30,770

 
31,409

 
30,727

 
 
 
 
 
 
 
 
Options to purchase shares of Common Stock and other stock-based awards outstanding which are not included in the calculation of diluted income per share because their impact is anti-dilutive

 
2

 
30

 
1

10.
Foreign Currency
The financial statements of Ultimate’s foreign subsidiaries, The Ultimate Software Group of Canada, Inc. (“Ultimate Canada”), The Ultimate Software Group of Asia, PTE. LTD. ("Ultimate Asia") and PeopleDoc SAS ("PeopleDoc"), have been translated into U.S. dollars. The functional currency of Ultimate Canada is the Canadian dollar. The functional currency of Ultimate Asia is the Singapore dollar. The functional currency of PeopleDoc is the euro. Assets and liabilities are translated into U.S. dollars at period-end exchange rates. Income and expenses are translated at the average exchange rate for the reporting period. The resulting translation adjustments, representing unrealized gains or losses, are included in accumulated other comprehensive (loss) income, a component of stockholders’ equity. Realized gains and losses resulting from foreign exchange transactions are included in total operating expenses in the unaudited condensed consolidated statements of income. There were no significant realized gains and losses resulting from foreign exchange transactions to the unaudited condensed consolidated statements of income for the three and nine months ended September 30, 2018 and September 30, 2017.
For the three and nine months ended September 30, 2018, Ultimate had unrealized translation losses of $2.3 million and $3.2 million, respectively. For the three and nine months ended September 30, 2017, Ultimate had unrealized translation gains of $0.9 million and $1.5 million, respectively. Included in accumulated other comprehensive income, as presented in the accompanying unaudited condensed consolidated balance sheets, are cumulative unrealized translation losses of $8.6 million as of September 30, 2018 and $5.4 million as of December 31, 2017.
11.
Stock-Based Compensation
Summary of Plans
Our Amended and Restated 2005 Equity and Incentive Plan (the “Plan”) authorizes the grant of options (“Options”) to non-employee directors, officers and employees of Ultimate to purchase shares of Common Stock.  The Plan also authorizes the grant to such persons of restricted and non-restricted shares of Common Stock, stock appreciation rights, stock units and cash performance awards (collectively, together with the Options, the “Awards”).
As of September 30, 2018, the aggregate number of shares of Common Stock that were available to be issued under all Awards granted under the Plan was 1,695,799 shares.
The following table sets forth the non-cash stock-based compensation expense resulting from stock-based arrangements that were recorded in our unaudited condensed consolidated statements of income for the periods indicated (in thousands):
 
For the Three Months Ended September 30,
 
For the Nine Months Ended September 30,
 
2018
 
2017
 
2018
 
2017
Non-cash stock-based compensation expense:
 
 
 
 
 
 
 
Cost of recurring revenues
$
4,172

 
$
3,072

 
$
11,598

 
$
8,869

Cost of services revenues
2,380

 
2,010

 
7,115

 
5,934

Sales and marketing
19,455

 
19,910

 
52,867

 
57,106

Research and development
4,392

 
3,093

 
11,942

 
9,004

General and administrative
6,303

 
9,929

 
20,534

 
30,245

Total non-cash stock-based compensation expense
$
36,702

 
$
38,014

 
$
104,056

 
$
111,158

Stock-based compensation for the three and nine months ended September 30, 2018 was $36.7 million and $104.1 million, respectively, as compared with stock-based compensation of $38.0 million and $111.2 million for the three and nine months ended September 30, 2017, respectively. The decreases of $1.3 million and $7.1 million in stock-based compensation for the three and nine month periods, respectively, included decreases of $6.6 million and $14.0 million, respectively, associated with modifications and terminations made to our change in control plans in March 2015, February 2016, and February 2017.  These changes were made to better align management's incentives with long-term value creation for our shareholders. As part of the modifications in connection with the terminations of the change in control plans, time-based restricted stock awards (vesting over three years) were granted to certain senior officers in March 2015, February 2016, and February 2017.
Stock-based compensation expense associated with modifications and terminations made to our change-in-control plans in March 2015, February 2016, and February 2017, is shown in the table below (in thousands):

15



 
 
For the Three Months Ended September 30,
 
For the Nine Months Ended September 30,
 
 
2018
 
2017
 
2018
 
2017
Stock-based compensation expense:
 
 
 
 
 
 
 
 
Stock-based compensation expense
 
$
26,289

 
$
20,984

 
$
70,135

 
63,229

Stock-based compensation expense related to change in control plans
 
10,413

 
17,030

 
33,921

 
47,929

Total non-cash stock-based compensation expense
 
$
36,702

 
$
38,014

 
$
104,056

 
$
111,158

Net cash proceeds from the exercise of Options were $0.3 million and $3.3 million for the three and nine months ended September 30, 2018, respectively, and $0.5 million and $5.0 million for the three and nine months ended September 30, 2017, respectively.
Stock Option, Restricted Stock and Restricted Stock Unit Activity
There were no Options granted during the three and nine months ended September 30, 2018. The following table summarizes stock option activity (for previously granted Options) for the nine months ended September 30, 2018 (in thousands, except per share amounts):
Stock Options
 
Shares
 
Weighted Average Exercise Price
 
Weighted Average Remaining Contractual Term (in Years)
 
Aggregate Intrinsic Value
Outstanding at December 31, 2017
 
114

 
$
29.24

 
0.4
 
$
21,476

Granted
 

 

 
0
 

Exercised
 
(110
)
 
29.78

 
0
 

Forfeited or expired
 

 

 
0
 

Outstanding at September 30, 2018
 
4

 
$
14.72

 
0.1
 
$
1,251

Exercisable at September 30, 2018
 
4

 
$
14.72

 
0.1
 
$
1,251

The aggregate intrinsic value of Options in the table above represents total pretax intrinsic value (i.e., the difference between the closing price of Common Stock on the last trading day of the reporting period and the exercise price times the number of shares) that would have been received by the option holders had all option holders exercised their Options on September 30, 2018. The amount of the aggregate intrinsic value changes, based on the fair value of Common Stock. Total intrinsic value of Options exercised was $2.7 million and $22.8 million for the three and nine months ended September 30, 2018, respectively, and $31.3 million and $59.4 million for the three and nine months ended September 30, 2017, respectively. All previously granted Options were fully vested as of December 31, 2011 and, therefore, no Options vested during the three and nine months ended September 30, 2018 and September 30, 2017, respectively.
As of September 30, 2018, there were no unrecognized compensation costs related to non-vested Options expected to be recognized as all previously granted Options were fully vested as of December 31, 2011.

16



The following table summarizes restricted stock awards and restricted stock unit awards granted during the three months ended September 30, 2018 and September 30, 2017 (in thousands):
 
 
For the Three Months Ended September 30,
 
 
2018
 
2017
Restricted Stock Awards:
 
 
 
 
Non-Employee Directors
 
2

 
2

Non-Senior Officers and Other Employees
 
44

 

Total Restricted Stock Awards Granted
 
46

 
2

 
 
 
 
 
Restricted Stock Unit Awards:
 
 
 
 
Non-Senior Officers and Other Employees
 
96

 
43

Total Restricted Stock Unit Awards Granted
 
96

 
43

The following table summarizes the activity pertaining to Common Stock previously issued under restricted stock awards and restricted stock unit awards which vested during the nine months ended September 30, 2018 and September 30, 2017 (in thousands):
 
 
For the Nine Months Ended September 30,
 
 
2018
 
2017
 
 
Shares Vested
Shares Retained (1)
Amount Retained (in millions) (1)
Shares Issued
 
Shares Vested
Shares Retained (1)
Amount Retained (in millions) (1)
Shares Issued
Restricted Stock Awards:
 
 
 
 
 
 
 
 
 
 
Non-Employee Directors
 
5


$0.0
5

 
31


$0.0
31

Senior Officers
 
396

150

34.0

246

 
278

109

21.3

169

Non-Senior Officers and Other Employees
 
5

2

0.3

3

 
2

1

0.1

1

Total Restricted Stock Awards
 
406

152

$34.3
254

 
311

110

$21.4
201

 
 
 
 
 
 
 
 
 
 
 
Restricted Stock Unit Awards:
 
 
 
 
 
 
 
 
 
 
Non-Senior Officers and Other Employees
 
266

90

$21.4
176

 
222

81

$15.9
141

Total Restricted Stock Unit Awards
 
266

90

$21.4
176

 
222

81

$15.9
141

______________________________
(1) During the nine months ended September 30, 2018 and September 30, 2017, of the shares released, 241,470 and 190,977 shares, respectively, were retained by Ultimate and not issued, in satisfaction of withholding payroll tax requirements applicable to the payment of such awards.

17



The following table summarizes restricted stock award and restricted stock unit activity for the nine months ended September 30, 2018 (in thousands, except per share values):
 
 
Restricted Stock Awards
 
Restricted Stock Unit Awards
 
 
Shares
 
Weighted Average Grant Date Fair Value
 
Shares
 
Weighted Average Grant Date Fair Value
Outstanding at December 31, 2017
 
882

 
$
179.95

 
630

 
$
170.73

Granted
 
276

 
239.13

 
419

 
242.94

Vested and released
 
(407
)
 
170.09

 
(266
)
 
178.65

Forfeited or expired
 

 

 
(29
)
 
207.55

Outstanding at September 30, 2018
 
751

 
$
207.00

 
754

 
$
218.71

As of September 30, 2018, $103.0 million of total unrecognized compensation costs related to non-vested restricted stock awards were expected to be recognized over a weighted average period of 1.56 years. As of September 30, 2018, $119.6 million of total unrecognized compensation costs related to non-vested restricted stock unit awards were expected to be recognized over a weighted average period of 1.88 years.

18



12.     Deferred Revenue and Performance Obligations
During the three months ended September 30, 2018 and 2017, $155.6 million and $129.3 million, respectively, of recurring revenues recognized, were included in the deferred revenue balances at the beginning of the respective periods. During the nine months ended September 30, 2018 and 2017, $162.1 million and $136.1 million, respectively, of recurring revenues recognized, were included in the deferred revenue balances at the beginning of the respective periods. Services revenues recognized in the same periods from deferred revenue balances at the beginning of the respective periods were not material.
Transaction Price Allocated to the Remaining Performance Obligations
As of September 30, 2018, approximately $1.8 billion of revenue is expected to be recognized from remaining SaaS performance obligations which includes the remaining period of their initial contract term as well as the remaining renewal periods under contract as of September 30, 2018. We expect to recognize revenue on approximately 48 percent of these remaining performance obligations over the next 12 months, with the balance recognized thereafter. Revenue from remaining performance obligations for services as of September 30, 2018 was not material.
13. Immaterial Correction of Prior Period Financial Statements

As described in Note 17 in our Notes to Consolidated Financial Statements in the Annual Report on Form 10-K for the year ended December 31, 2017, filed with the SEC on February 26, 2018, we revalued our net deferred tax assets to implement the federal Tax Cuts and Jobs Act (the "Tax Act") which the federal government passed on December 22, 2017. During the year ended December 31, 2017, immaterial errors were discovered in prior periods in the reporting of the GAAP income tax expense associated with the stock-based compensation for certain of our executive officers. While we have concluded that the impact of these errors on our previously-issued unaudited condensed consolidated statements of income and unaudited condensed consolidated statements of comprehensive income was not material, we have revised our previously-reported unaudited condensed consolidated statements of income and unaudited condensed consolidated statements of comprehensive income for the three and nine months ended September 30, 2017. The revisions include a decrease to GAAP net income for the three months ended September 30, 2017 of $0.4 million, as a result of the increase to our GAAP income tax expense for the third quarter of 2017, and a decrease to GAAP net income for the nine months ended September 30, 2017 of $0.9 million. For the third quarter of 2017, there was no impact on previously reported cash flows, pre-tax income and non-GAAP results. The revisions to our unaudited condensed consolidated statements of income and unaudited condensed consolidated statements of comprehensive income for the three and nine months ended September 30, 2017 are as follows (in thousands, except per share amounts):


19



Unaudited Condensed Consolidated Statements of Income
For the Three Months Ended
 
For the Nine Months Ended
 
September 30, 2017
 
September 30, 2017
 
As Reported
 
As Revised
 
As Reported
 
As Revised
Income before income taxes
$
14,297

 
$
14,297

 
$
24,182

 
$
24,182

(Provision) benefit for income taxes
(9,600
)
 
(9,954
)
 
(7,149
)
 
(8,070
)
Net income
$
4,697

 
$
4,343

 
$
17,033

 
$
16,112

 
 
 
 
 
 
 
 
Net income per share:
 
 
 
 
 
 
 
Basic
$
0.16

 
$
0.15

 
$
0.57

 
$
0.54

Diluted
$
0.15

 
$
0.14

 
$
0.55

 
$
0.52

 
 
 
 
 
 
 
 
Unaudited Condensed Consolidated Statement of Comprehensive Income
 
 
 
 
 
 
 
Net income
$
4,697

 
$
4,343

 
$
17,033

 
$
16,112

Other comprehensive income, net of tax
929

 
929

 
1,341

 
1,341

Comprehensive income
$
5,626

 
$
5,272

 
$
18,374

 
$
17,453



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. and its subsidiaries (“Ultimate,” “we,” “us,” or “our”) 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 (this “Form 10-Q”) and in conjunction with Ultimate’s Annual Report on Form 10-K for the fiscal year ended December 31, 2017, filed with the Securities and Exchange Commission (the “SEC”) on February 26, 2018 (the “Form 10-K”).
Business Overview
Ultimate Software is a leading provider of cloud-based human capital management solutions, often referred to as human capital management (“HCM”). Ultimate's UltiPro product suite (“UltiPro”) is a comprehensive, engaging solution that has human resources ("HR"), payroll, and benefits management at its core, including global people management and talent, compensation, and time and labor management. UltiPro is available in 14 languages with more than 37 country-specific localizations. The solution is delivered via software-as-a-service ("SaaS"), now more commonly known as the cloud computing model, to organizations based in the United States and Canada, including those with global workforces. As of September 30, 2018, we had approximately 4,500 organizations as customers and more than 40 million people records in our HCM cloud. We attained our leadership position, we believe, through our focus on unified HCM, people-centric product design, cloud technology, and strong customer relationships.
UltiPro is designed to deliver the functionality businesses need to manage the complete employee life cycle from recruitment to retirement and to facilitate high levels of employee engagement with their employers and one another. The solution includes unified feature sets for recruiting and onboarding, HR management and compliance, benefits management and online enrollment, payroll, performance management, employee engagement surveying, compensation management with salary planning, budgeting, incentive award planning, succession management, learning management, reporting and analytical decision-making and predictive tools, and time capture, scheduling, attendance tracking, and absence accruals. UltiPro has role-based features for HR professionals, executives, managers, administrators, and employees whether they are in or out of the office, including access to business-critical information on mobile devices such as the iPhone, iPad, and other smartphones and tablets.
Our customers tell us that UltiPro helps them to streamline talent management, HR and payroll processes to significantly reduce administrative and operational costs while also empowering them to manage the talent in their workforces more strategically. UltiPro provides our customers tools to analyze workforce trends for better decision making, identify high-performing talent within their organizations, predict who future high-performers and retention risks will be with a high degree of accuracy, find critical information quickly, and perform routine business activities efficiently.
Our cloud offering of UltiPro provides web-based access to comprehensive HCM functionality for organizations that want to simplify delivery and support of their business applications. We have found that UltiPro is attractive to companies that want to focus on their core competencies to increase sales and profits while we supply and manage the hardware, infrastructure, ongoing maintenance, and backup services for our customers.
We market our UltiPro solutions primarily to enterprise companies, which we define as organizations with 2,501 or more employees, including those with 10,000 employees and larger; mid-market companies, which we define as those having 501-2,500 employees; and strategic market companies, which we define as those having 100-500 employees. Our mid-market and strategic customers have access to nearly all the features that our larger enterprise companies have through UltiPro, plus a bundled services package. Since many companies in the mid- and strategic markets do not have information technology (“IT”) staff on their premises to help with system deployment or ongoing management issues, we have created a bundled services package to give these customers a high degree of convenience by handling system configuration, business rules, and other situations for them “behind the scenes.” UltiPro is marketed primarily through our enterprise, mid-market, and strategic direct sales teams.
In addition to UltiPro's HCM functionality, our customers have the option to purchase a number of additional capabilities on a per-employee-per-month (“PEPM”) basis, which are available to enhance and complement the core functionality of UltiPro and which are based on the particular business needs of our customers. These optional UltiPro capabilities currently include (i) the talent acquisition suite (recruitment and onboarding); (ii) the talent management suite (performance management, talent predictors, and succession management); (iii) learning management; (iv) employee engagement surveys; (v) compensation management; (vi) benefits enrollment; (vii) time management; (viii) payment services; (ix) wage attachments; (x) UltiPro ACA toolkit and (xi) other optional features (collectively, “Optional Capabilities”).
All Optional Capabilities are priced solely on a subscription basis. Some of the Optional Capabilities are available to enterprise, mid-market and strategic market customers while others are available exclusively to either enterprise, mid-market or

20



strategic market customers, and availability is based on the needs of the respective customers, the number of their employees and the complexity of their HCM environment.

The key drivers of our business are (i) growth in recurring revenues; (ii) operating income, excluding non-cash stock-based compensation, amortization of acquired intangibles, and transaction costs for business combinations ("Non-GAAP Operating Income"); and (iii) retention of our customers once our solutions are sold (“Customer Retention”). For the three months ended September 30, 2018, our (i) recurring revenues grew by 25.4%, compared with the same period in 2017, and (ii) Non-GAAP Operating Income was $57.7 million, or 20.1% of total revenues, as compared with $53.3 million, or 22.6% of total revenues, for the same period in 2017. For the nine months ended September 30, 2018, our (i) recurring revenues grew by 24.2%, compared with the same period in 2017, and (ii) Non-GAAP Operating Income was $170.0 million or 20.3% of total revenues, as compared with $138.0 million, or 20.0% of total revenues, for the same period in 2017. As of September 30, 2018, our Customer Retention, on a trailing twelve-month basis, was approximately 96% for our recurring revenue cloud customer base. See “Non-GAAP Financial Measures” below.
Our ability to achieve significant revenue growth in the future will depend upon the success of our direct sales force and our ability to adapt our sales efforts to address the evolving markets for our products and services. We provide our sales personnel with comprehensive and continuing training with respect to technology and market place developments. Aside from sales commissions, we also provide various incentives to encourage our sales representatives, including stock-based compensation awards based upon performance.
The HCM market is intensely competitive. We address competitive pressures through improvements and enhancements to our products and services, the development of additional features of UltiPro and a comprehensive marketing team and process that distinguishes Ultimate and its products from the competition.  Our focus on customer service, which enables us to maintain a high Customer Retention rate, also helps us address competitive pressures.
As our business has grown, we have become increasingly subject to the risks arising from adverse changes in domestic and global economic conditions. If general economic conditions were to deteriorate, we may experience delays in our sales cycles, increased pressure from prospective customers to offer discounts and increased pressure from existing customers to renew expiring recurring revenue agreements for lower amounts. We address continuing economic pressures by, among other things, efforts to control growth of our operating expenses through the monitoring of controllable costs and vendor negotiations.
Ultimate has two primary revenue sources: recurring revenues and services revenues. The primary component of recurring revenues is subscription revenues from our cloud offering of UltiPro. The majority of services revenues are derived from implementation consulting services.
As cloud units are sold, the recurring revenue backlog associated with UltiPro grows, enhancing the predictability of future revenue streams. Cloud revenues include ongoing monthly subscription fees, priced on a PEPM basis. Revenue recognition for our recurring revenue stream is typically triggered when the customer processes its first payroll using UltiPro (or goes “Live”).

Acquisition

On July 26, 2018, Ultimate, PeopleDoc SAS, a simplified joint-stock company (société par actions simplifiée) organized under the laws of France (“PeopleDoc”) and certain shareholders of PeopleDoc, entered into a Share Purchase Agreement (the “Purchase Agreement”) and on July 27, 2018, the parties consummated the transactions contemplated by the Purchase Agreement and Ultimate acquired PeopleDoc. PeopleDoc, a pioneer in HR Service Delivery. is based in Paris, France and has more than 1,000 customers with users in 180 countries. The addition of the PeopleDoc HR Service Delivery platform will further Ultimate's mission to improve the employee experience by offering new, person-centric features, such as an online employee help center, HR case management, and employee file management. See Note 4 of the Notes to Unaudited Condensed Consolidated Financial Statements.

Critical Accounting Estimates
The preparation of 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 materially from those estimates.  Ultimate’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 with the exception of our revenue recognition policy due to the

21



adoption of Accounting Standards Update No. 2014-09, “Revenue from Contracts with Customers (Topic 606)” (“Topic 606”). See note 3 in our Notes to Unaudited Condensed Consolidated Financial Statements for further discussion on Topic 606.

Results of Operations
The following table sets forth the unaudited condensed consolidated statements of income data of Ultimate, as a percentage of total revenues, for the periods indicated:
 
For the Three Months Ended September 30,
 
For the Nine Months Ended September 30,
 
2018
 
2017
 
2018
 
2017
Revenues:
 
 
 
 
 
 
 
Recurring
88.4
 %
 
86.0
 %
 
87.4
 %
 
85.3
 %
Services
11.6

 
14.0

 
12.6

 
14.7

Total revenues
100.0

 
100.0

 
100.0

 
100.0

Cost of revenues:
 

 
 

 
 
 
 
Recurring
24.8

 
22.3

 
24.0

 
22.5

Services
14.1

 
15.3

 
14.2

 
15.6

Total cost of revenues
38.9

 
37.6

 
38.2

 
38.1

Gross profit
61.1

 
62.4

 
61.8

 
61.9

Operating expenses:
 

 
 

 
 
 
 
Sales and marketing
25.0

 
27.5

 
25.1

 
29.2

Research and development
17.8

 
16.3

 
17.7

 
15.9

General and administrative
13.0

 
12.5

 
12.1

 
13.2

Total operating expenses
55.8

 
56.3

 
54.9

 
58.3

Operating income
5.3

 
6.1

 
6.9

 
3.6

Other income (expense):
 

 
 

 
 
 
 
Interest expense and other
(0.1
)
 

 
(0.1
)
 
(0.1
)
Other income, net
0.5

 

 
0.3

 

Total other income (expense), net
0.4

 

 
0.2

 
(0.1
)
Income before income taxes
5.7

 
6.1

 
7.1

 
3.5

Benefit (provision) for income taxes
0.2

 
(4.3
)
 
(0.9
)
 
(1.2
)
Net income
5.9
 %
 
1.8
 %
 
6.2
 %
 
2.3
 %
The following table sets forth the non-cash stock-based compensation expense resulting from stock-based arrangements that is recorded in our unaudited consolidated statements of income for the periods indicated (in thousands):
 
For the Three Months Ended September 30,
 
For the Nine Months Ended September 30,
 
2018
 
2017
 
2018
 
2017
Cost of recurring revenues
$
4,172

 
$
3,072

 
$
11,598

 
$
8,869

Cost of services revenues
2,380

 
2,010

 
7,115

 
5,934

Sales and marketing
19,455

 
19,910

 
52,867

 
57,106

Research and development
4,392

 
3,093

 
11,942

 
9,004

General and administrative
6,303

 
9,929

 
20,534

 
30,245

Total stock-based compensation expense
$
36,702

 
$
38,014

 
$
104,056

 
$
111,158

Revenues
Our revenues are derived from recurring revenues and services revenues.

22



Total revenues increased 21.9% to $287.8 million for the three months ended September 30, 2018 from $236.1 million for the three months ended September 30, 2017 and 21.2% to $835.7 million for the nine months ended September 30, 2018 from $689.3 million for the nine months ended September 30, 2017.
Recurring revenues, primarily consisting of subscription-based SaaS revenues, increased 25.4% to $254.6 million for the three months ended September 30, 2018, from $203.1 million for the three months ended September 30, 2017 and 24.2% to $730.6 million for the nine months ended September 30, 2018, from $588.2 million for the nine months ended September 30, 2017. The increases for the three and nine months ended September 30, 2018 in recurring revenues, was primarily based on the revenue impact of incremental units sold to customers that have processed their first payroll using UltiPro (or gone "Live") since September 30, 2017, including the UltiPro core product and, to a lesser extent, Optional Capabilities of UltiPro. Cloud subscription-based SaaS revenues are recognized as recurring revenues over the initial contract period, as those services are delivered, typically commencing with the Live date.
Our annual revenue customer retention rate for our recurring revenue cloud customer base was approximately 96% as of September 30, 2018 (calculated on a 12-month rolling basis), which is consistent with the same period of the prior year. The impact on recurring revenues of UltiPro units sold has been a gradual increase from one reporting period to the next, based on the incremental effect of revenue recognition of the subscription fees over the terms of the related contracts as sales in backlog go Live.
Services revenues increased 0.6% to $33.2 million for the three months ended September 30, 2018 from $33.1 million for the three months ended September 30, 2017 and 4.0% to $105.1 million for the nine months ended September 30, 2018 from $101.1 million for the nine months ended September 30, 2017. The increase in services revenues for the three month period was primarily due to Other Services revenues. The increase in services revenues for the nine month period was mainly attributable to additional implementation revenues to support increased sales, from both Ultimate's implementation consultants as well as third party implementation partners and, to a lesser extent, an increase in Other Services revenues mainly attributable to our print services for certain customers.
Cost of Revenues
Cost of revenues consists of the costs of recurring and services revenues. Cost of recurring revenues primarily consists of costs to provide customer support services ("Customer Support") to cloud customers, the cost of providing periodic updates and the cost of recurring subscription revenues, including hosting data center costs and, to a lesser extent, amortization of capitalized software. Cost of services revenues primarily consists of costs to provide implementation services and training to Ultimate’s customers and, to a lesser extent, costs related to sales of payroll-related forms, time clocks and print services, as well as costs associated with certain client reimbursable out-of-pocket expenses.
Total cost of revenues increased 26.1% to $111.8 million for the three months ended September 30, 2018, from $88.7 million for the three months ended September 30, 2017 and 21.5% to $319.2 million for the nine months ended September 30, 2018, from $262.6 million for the nine months ended September 30, 2017.
Cost of recurring revenues increased 35.6% to $71.2 million for the three months ended September 30, 2018 from $52.6 million for the three months ended September 30, 2017 and 29.4% to $200.7 million for the nine months ended September 30, 2018 from $155.2 million for the nine months ended September 30, 2017. The increases in the cost of recurring revenues for the three- and nine-month periods were primarily due to increases in both cloud costs and Customer Support costs, as described below, and, to a lesser extent, increased amortization of capitalized software costs from the development costs related to a development project to be sold in the future as a cloud product only (the "Development Project") which resulted from product modules becoming available for their intended use since September 30, 2017.
For the three and nine months ended September 30, 2018, the increases in cloud costs was principally as a result of the growth in cloud operations from increased sales, including increased labor costs and, to a lesser extent, increased variable costs associated with our cloud operations.
The increases in Customer Support costs for the three and nine months ended September 30, 2018 were primarily due to higher labor costs commensurate with the growth in the number of cloud customers serviced.
Cost of services revenues increased 12.3% to $40.6 million for the three months ended September 30, 2018 from $36.1 million