10-K 1 ulti-20181231x10k.htm 10-K Document
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
_______________
FORM 10-K
 
 
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
 
For the fiscal year ended December 31, 2018
or
 
 
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
incorporation or organization)
Identification No.)
 
 
2000 Ultimate Way,
33326
Weston, FL
(Zip Code)
(Address of principal executive offices)
 
Registrant’s telephone number, including area code:
(954) 331-7000
Securities registered pursuant to Section 12(b) of the Act: 
Title of Each Class:
Name of Each Exchange on which Registered:
Common Stock, par value $.01 per share
The Nasdaq Stock Market LLC
 
(NASDAQ Global Select Market)
Securities registered pursuant to Section 12(g) of the Act:
None
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.  Yes   No ☐
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.  Yes  ☐   No
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 if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§229.405 of this chapter) is not contained herein, and will not be contained, to the best of Registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. ☐
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
x
 
 
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 revised 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 Act).  Yes  ☐   No
The aggregate market value of Common Stock, par value $.01 per share, held by non-affiliates of the Registrant, based upon the closing sale price of such shares on the NASDAQ Global Select Market on June 30, 2018 was approximately $7.6 billion.



As of February 28, 2019, there were 31,680,177 shares of the Registrant’s Common Stock, par value $.01, outstanding.




THE ULTIMATE SOFTWARE GROUP, INC.

INDEX

 
 
Page(s)
 
 
PART I
 
Item 1.
Item 1A.
Item 1B.
Item 2.
Item 3.
Item 4.
 
PART II
 
Item 5.
Item 6.
Item 7.
Item 7A.
Item 8.
Item 9.
Item 9A.
 
Item 9B.
 
PART III
 
Item 10.
Item 11.
Item 12.
Item 13.
Item 14.
 
PART IV
 
Item 15.

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This Annual Report on Form 10-K for the fiscal year ended December 31, 2018 (this “Form 10-K”) of The Ultimate Software Group, Inc. and subsidiaries (“Ultimate,” "Ultimate Software," “we,” “us” or “our”) may contain certain forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. These forward-looking statements represent our expectations or beliefs, including, but not limited to, our expectations concerning our operations and financial performance and condition, and our expectations regarding our ability to complete the Merger (as defined below) and the timing of such Merger, as well as our ability to realize the anticipated benefits from the Merger. 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. Ultimate’s actual results could differ materially from those contained in the forward-looking statements due to risks and uncertainties associated with fluctuations in our quarterly operating results, concentration of our  product offerings, development risks involved with new products and technologies, competition, our contractual relationships with third parties, contract renewals with business partners, compliance by our customers with the terms of their contracts with us, and other factors disclosed in Ultimate’s filings with the Securities and Exchange Commission. Risks and uncertainties related to the Merger include, but are not limited to, the occurrence of any event, change or other circumstance that could give rise to the termination of the Merger Agreement (as defined below); the failure of the parties to satisfy conditions to completion of the Merger, including the failure of our stockholders to approve the Merger or the failure of the parties to obtain required regulatory approvals; the risk that regulatory or other approvals are delayed or are subject to terms and conditions that are not anticipated; changes in our business or in our or our businesses’ operating prospects; the impact of the announcement of, or failure to complete, the Merger on our relationships with employees, customers, vendors and other business partners; and potential litigation related to the Merger. Other factors that may cause such differences include, but are not limited to, those discussed in this Form 10-K, including the risk factors set forth in Item 1A. Ultimate undertakes no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise.
UltiPro® and its related design are registered trademarks of Ultimate in the United States. This Form 10-K also includes names, trademarks, service marks and registered trademarks and service marks of companies other than Ultimate.
PART I
Item 1. Business
Overview
With offices in the United States, Canada, France, Germany, England, and Singapore, Ultimate Software is a leading provider of cloud-based human capital management solutions-often referred to as human capital management ("HCM")-and employee experience solutions. Ultimate's UltiPro product suite is a comprehensive, engaging solution that has human resources ("HR") and payroll at its core and includes benefits management, talent acquisition, talent management, time management, and global people management functionality available in 14 languages with 61 country-specific localizations. Ultimate also offers a-la-carte employee experience solutions, such as HR Service Delivery and "Perception," an employee-sentiment analysis solution.
Ultimate's solutions are delivered via software-as-a-service ("SaaS"), now more commonly known as cloud computing, to organizations with employees in the United States, Canada, Europe, Asia Pacific, and other global locations. At the close of 2018, we had more than 5,600 organizations as customers and more than 48 million people records in our cloud environment. We attained our leadership position, we believe, through our exclusive focus on solutions that help companies manage their employees in an engaging way. Key factors in our success have been our people-centric product design, cloud technology, and strong customer relationships nurtured by our services team and throughout the Ultimate organization.
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 talent acquisition and onboarding, HR service delivery and management, 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 and functions on mobile devices such as the iPhone, iPad, and Android 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 and develop the talent in their

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workforces more strategically. UltiPro provides our customers intelligent tools and insights for engaging workforces and understanding organizational dynamics, analyzing trends for better decision making, identifying high-performing talent, predicting who future high-performers and what retention risks will be with a high degree of accuracy, finding critical information quickly and performing routine business activities efficiently.
Our cloud offering of UltiPro provides web-based and mobile 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.
Merger Agreement
On February 3, 2019, Ultimate entered into an Agreement and Plan of Merger (the “Merger Agreement”) with Unite Parent Corp., a Delaware corporation (“Parent”), and Unite Merger Sub, Inc., a Delaware corporation and an indirect wholly owned subsidiary of Parent (“Merger Sub”). Pursuant to the Merger Agreement, Ultimate would be acquired by an investor group led by Hellman & Friedman (“H&F”), a leading private equity investment firm, in an all-cash transaction for $331.50 per share in cash (representing an aggregate value of approximately $11 billion), after which Ultimate would operate as a privately held company. Parent is a newly-formed entity that will be owned by the investor group.
The Merger Agreement provides, among other things and subject to the terms and conditions set forth therein, that Merger Sub will be merged with and into Ultimate (the “Merger”), with Ultimate continuing as the surviving corporation and as an indirect wholly owned subsidiary of Parent. The Merger Agreement provides that each share of common stock, par value $0.01 per share, of Ultimate (“Common Stock”) outstanding immediately prior to the effective time of the Merger (the “Effective Time”) (other than shares of Common Stock owned by Ultimate in treasury, Parent, Merger Sub or any wholly owned subsidiary of Ultimate or Parent and shares of Common Stock owned by stockholders of Ultimate who properly demand and do not withdraw a demand for, or lose their right to, appraisal rights pursuant to Section 262 of the General Corporation Law of the State of Delaware) will at the Effective Time automatically be cancelled and converted into the right to receive $331.50 in cash (the “Merger Consideration”), without interest and subject to applicable withholding taxes.
Pursuant to the Merger Agreement, as of the Effective Time, (i) each Ultimate stock option will become fully vested and be converted into the right to receive an amount in cash equal to the product of (A) the excess, if any, of the Merger Consideration over the applicable exercise price of such option, multiplied by (B) the number of shares subject to such option, subject to applicable withholding taxes, and (ii) each restricted stock award and restricted stock unit award that is outstanding immediately prior to the Effective Time will, whether granted prior to the date of the Merger Agreement or granted on or after the date of the Merger Agreement, become fully vested and be converted into the right to receive the Merger Consideration in respect of each underlying share of Common Stock, subject to applicable withholding taxes.
Ultimate’s board of directors (the “Board of Directors ” or the “Board”) has unanimously approved and declared advisable the Merger Agreement and the transactions contemplated thereby, including the Merger. The obligation of the parties to complete the Merger is subject to customary closing conditions, including, among others, (i) the adoption of the Merger Agreement by a majority of outstanding shares of Common Stock entitled to vote thereon (the “Company Stockholder Approval”), (ii) the expiration or earlier termination of the applicable waiting period under the Hart-Scott-Rodino Antitrust Improvements Act of 1976, as amended, and the decisions, orders, consents or expiration of any waiting periods required to consummate the Merger under the anti-competition laws of certain foreign jurisdictions have occurred or been granted, (iii) the absence of any law, order or injunction of a court or governmental entity of competent jurisdiction prohibiting the consummation of the Merger, (iv) the accuracy of the representations and warranties contained in the Merger Agreement (subject to certain qualifications), (v) the performance in all material respects by the parties of their respective obligations under the Merger Agreement that are required to be performed at or prior to the Effective Time and (vi) the absence of a Company Material Adverse Effect (as defined in the Merger Agreement) occurring after the date of the Merger Agreement.

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Ultimate has made customary representations, warranties and covenants in the Merger Agreement, including, among others, covenants (i) to conduct its business in all material respects in the ordinary course during the period between the execution of the Merger Agreement and the closing of the Merger, and not to engage in specified types of transactions during this period, subject to certain exceptions and (ii) to convene a meeting of its stockholders for the purpose of obtaining the Company Stockholder Approval. The Merger Agreement provides for a 50 day “go-shop” period beginning on February 3, 2019, and continuing until 11:59 p.m., New York City time, on March 25, 2019, during which period the Board of Directors and Ultimate’s financial advisor are permitted to actively initiate, solicit and encourage alternative acquisition proposals from third parties and to provide information to, and participate in discussions and engage in negotiations with, third parties regarding any alternative acquisition proposals. After such 50-day go-shop period and subject to certain exceptions, Ultimate will be subject to customary “no-shop” restrictions prohibiting it from soliciting alternative acquisition proposals, engaging in discussions or negotiations with respect to such proposals or providing non-public information in connection with such proposals. Subject to certain exceptions, the Board of Directors is required to recommend that Ultimate’s stockholders adopt the Merger Agreement and may not withhold, withdraw, qualify or modify in a manner adverse to Parent such recommendation or take certain similar actions which are referred to in the Merger Agreement as a “Change of Recommendation”. However, Ultimate may, prior to the time the Company Stockholder Approval is obtained, make a Change of Recommendation in connection with a Superior Proposal or Intervening Event (each as defined in the Merger Agreement), and in the case of a Superior Proposal, terminate the Merger Agreement, if Ultimate complies with certain notice and other requirements.
The Merger Agreement contains certain termination rights, including, among others, (i) the right of either party to terminate the Merger Agreement if the Merger is not consummated on or before August 3, 2019, or if the Company Stockholder Approval is not obtained at a meeting of the Company’s stockholders at which a vote on the adoption of the Merger Agreement is taken; (ii) the right of Ultimate to terminate the Merger Agreement (a) if Parent and Merger Sub fail to consummate the Merger following satisfaction or waiver of the conditions to Parent’s obligation to consummate the Merger and completion of a specified marketing period for Parent’s debt financing or (b) prior to the time the Company Stockholder Approval is obtained, in order to substantially concurrently enter into an agreement providing for a Superior Proposal, subject to complying with the terms of the Merger Agreement; and (iii) the right of Parent to terminate the Merger Agreement prior to the time the Company Stockholder Approval is obtained if the Board of Directors effects a Change of Recommendation. The Merger Agreement provides that, upon termination of the Merger Agreement under specified circumstances, Ultimate will be required to pay Parent a termination fee of $331 million; provided that if Ultimate terminates the Merger Agreement during the 50-day go-shop period and simultaneous with such termination enters into a definitive agreement for an alternative acquisition, then the termination fee payable by Ultimate to Parent will be $110 million. The Merger Agreement further provides that Parent will be required to pay Ultimate a termination fee of $550 million if the Merger Agreement is terminated under specified circumstances.
Cloud Computing Model
Market acceptance of cloud computing for mission critical enterprise applications has become increasingly common in recent years since software can be delivered cost-effectively, reliably, and securely to businesses over the Internet, eliminating the need for customers to purchase supporting software and hardware for an on-premise system and the need to hire IT staff to monitor, maintain, and upgrade such a system.
We introduced our first subscription-based service solution over the Internet in December of 2000, and we began marketing our first multi-tenant SaaS HCM to enterprise companies in 2002. Since that time, we have significantly expanded our HCM offerings and the cloud infrastructure that supports them. Today, we develop our solutions using cloud-native technologies and architectural patterns to provide our customers with solutions that are effective, engaging, flexible, and resilient. Our cloud model is based on a multi-tenant architecture that is both open and secure with support for user experiences on both desktop and mobile devices. Our customers that have moved away from traditional on-premise software to our cloud-based service applications benefit by substantially reducing the cost and complexity typical of on-premise software implementations, customizations, and upgrades. Through our cloud-based delivery model, we supply and manage the hardware, infrastructure, ongoing maintenance, and backup services for our customers. We install the latest version of our software for our customers, reducing their need to buy and maintain their own technology infrastructure resources, and as a part of our cloud model, we also provide launch and training services to our customers as well as ongoing support services.
Our cloud-based solutions are hosted in eight data centers: one located near Atlanta, Georgia, one near Phoenix, Arizona, one near Toronto, Canada, one near Vancouver, Canada, one near Ashburn, Virginia, one near Dallas, Texas, one near Frankfurt, Germany and the eighth near Paris, France. Our data center facilities are owned and operated by independent third parties, who provide redundant power, bandwidth, and physical security. Ultimate employees deploy, monitor, and manage our hardware and software systems in accordance with our security and data privacy policies, which are subject to examination by an independent third-party.

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Market Share
Based on our customer counts and market data from Hoover's/Dun & Bradstreet as of January 5, 2019, we estimate our approximate share of the total available market (TAM) at the close of 2018 to be approximately 7 percent for enterprise companies, 12 percent for mid-market companies, and 3 percent for companies in the strategic market.
Company Information
Ultimate is a Delaware corporation formed in April 1996 to assume the business and operations of The Ultimate Software Group, Ltd. (the “Partnership”), a limited partnership founded in 1990. During August 2006, Ultimate formed a wholly-owned subsidiary, The Ultimate Software Group of Canada, Inc. (“Ultimate Canada”), to accommodate our operations in Canada. During February 2015, Ultimate formed a wholly-owned subsidiary, The Ultimate Software Group of Asia, PTE. LTD. In July 2018, Ultimate acquired PeopleDoc SAS, a simplified joint-stock company (société par actions simplifiée) organized under the laws of France (“PeopleDoc”) and formed a wholly-owned subsidiary, PeopleDoc SAS, based in Paris, France. There were no material assets or revenues in Canada, Singapore or Europe as of or for the year ended December 31, 2018. Ultimate's headquarters is located at 2000 Ultimate Way, Weston, Florida 33326, and our telephone number is (954) 331-7000.
Capabilities of UltiPro
UltiPro is a comprehensive cloud-based solution 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 feature sets for talent acquisition and onboarding, HR service delivery and management, compliance, benefits management and online enrollment, payroll, performance management, employee engagement surveying, compensation management, succession management, learning management, reporting and analytical decision-making tools, time and attendance, and role-based self-service capabilities for executives, managers, administrators, and employees whether they are in or out of the office. UltiPro offers the following capabilities to our customers:
Role-Based Internet Access to Functionality. UltiPro provides web and mobile access to workforce-related business functions, company communications, and reporting for everyone in our customer's organization, not just the HR department. The access and specific functionality can be tailored to our customer's process requirements and the individual user's role. We believe that UltiPro's employee-facing web applications can increase management and administrative efficiencies by providing immediate access to reporting, staff management processes and business intelligence for business leaders, and can reduce operating costs by eliminating the need for organizations to print and distribute paper communications, handbooks, forms, and paychecks. Using tablets or smartphones, employees can manage their goals, provide feedback to managers, search and apply for career opportunities, access their own personal information, such as pay statements, and view their company's employee directory to look up contact information or employee photos. In addition, managers can approve or deny daily workflow transactions, such as salary changes and paid time off, access reports and analytics, and readily review goals, competencies, and accomplishments of their team members.
Rich and Highly Configurable Functionality. UltiPro has rich functionality built into the solution and provides extensive capabilities for configuration and integration. As a result, we have found that our customers can avoid extensive customizations and yet are able to achieve a highly tailored solution to meet their specific business needs. Since UltiPro's feature-sets are unified, our customers can streamline their management of the total employment cycle and can generate strategic HR and talent management insights from UltiPro as their primary, central system of record for their employee data.
Flexible, Rapid System Setup and Configuration. UltiPro and our streamlined UltiPro Launch Experience have been designed to minimize the time and effort required to set up and configure the system to address individual company needs. Largely because our UltiPro solutions deliver extensive functionality that can be configured to align with our customers' various business models with few customizations, our setup of new customers is faster and simpler than implementations typical of legacy, on-premise software.
Reduced Total Cost of Ownership. We believe that the UltiPro solution provides cost saving opportunities for our customers and that UltiPro is competitively priced. In addition, we believe that our current practices in launching the UltiPro solution result in cost savings for customers when compared with implementations of other similar solutions in the industry. The UltiPro customer may also reduce the administrative and IT support costs associated with the organization's HR, benefits and payroll functions over time. Administrative costs are often further reduced by providing an organization with greater access to information, streamlined HR processes and transactions, and control over reporting.

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Modern Cloud-Native Technologies. We are consistently focused on evolving our cloud architecture, leveraging the most appropriate technologies, platforms, and patterns to solve business challenges and deliver value to our customers. The primary characteristics of our technology and cloud architecture are:

Multi-Tenant SaaS offering. We take on the responsibility of delivery, maintenance, and upgrades. This allows us to serve all our customers from a single code base for each of our offerings, reducing complexity and improving reliability.
Cloud-Native Applications and Platforms. Micro-Service oriented applications deployed on robust Infrastructure as a Service (IaaS) and Platform as a Service (PaaS) backed cloud platforms allow our offerings to scale and better react to changing demands, leading to more resilient and reliable solutions for our customers.
A highly configurable platform that enables customers to achieve a tailored UltiPro experience for their businesses without incurring the high expense of custom software.
Extensible offerings that leverage web services and event-based integrations to expose functionality to the outside world, including an extensive network of partners.
Industry-leading tools, technologies and design patterns including, but not limited to, Microsoft .NET, Java/Spring, Python, AngularJS, Openstack and Docker Containers to streamline the complexities of our HCM domain and focus on how our users want to use UltiPro rather than expect them to change their behavior to accommodate our product.

Rich End-User Experience, Ease of Use and Navigation. We design our products to be user-friendly and to simplify the complexities of managing employees and complying with government regulations in the HR, payroll, and talent management areas. UltiPro uses familiar, consumer-style navigation, which we believe makes our solution convenient and easy to use. While traveling or out of the office, our customer's HR professionals, executives, managers, administrators, and employees can manage payroll and employee functions and run reports by accessing UltiPro over the Internet or find answers to key routine questions by using the UltiPro application on their mobile devices.
Comprehensive Customer Services and Industry-Specific Expertise. We provide several types of customer service: cloud services, professional setup and launch services, customer support services, knowledge (or training) services, and a group of optional service offerings we call Select Services that includes payment services (such as tax filing, garnishment management and check printing), ongoing managed services, and other specific-need services such as filing the Patient Protection and Affordable Care Act ("ACA") compliance documents for customers. The voice of our customers is incorporated into all of our processes, and all of our services are designed to create a positive, proactive and productive UltiPro experience for our customers. We have multiple avenues for our customers to give us feedback and recommendations on product enhancements, and we provide our customers a portal where they can choose to learn about UltiPro and Ultimate in the style that best suits them — online webinars, videos, instructional documents, online chats, customer communities, and other vehicles. We recognize the importance of issuing timely updates that reflect changes in tax and other regulatory laws and employ a dedicated research team to track jurisdictional tax changes for more than 10,000 active tax codes included in UltiPro as well as changes in other employee-related regulations.
Managed Services. As part of our mission to simplify the work lives of our customers’ human resources and payroll people, we introduced UltiPro Managed Services in 2013. These managed services are now part of our Select Services offerings and are designed for those customers who want to outsource some components of their HR, payroll, benefits, and HCM technology management functions without sacrificing the control of, or access to, their employee data that they enjoy with our cloud solution. Unlike other outsourced payroll or Human Resources Information System ("HRIS") services that typically take a one-size-fits-all approach, our customers can select from a variety of payroll management, HRIS, and/or benefits management services and combine them into a tailored bundle that best suits their unique needs.
UltiPro Standard Functionality and Optional Capabilities
UltiPro's standard functionality includes, but is not limited to, a set of role-based features that engage employees while allowing HR generalists as well as benefits, compensation, and payroll managers and other business managers to develop, coach, evaluate and reward their people and meet organizational objectives. Business intelligence along with system configuration tools and integration capabilities support our customers' connections with third-party applications and providers. UltiPro also includes employee relations' tools for managing disciplinary actions and grievances, and health and safety incidents.
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

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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 and scheduling management; (viii) payment services; (ix) wage attachments; (x) HR service delivery; and (xi) other optional features (collectively, “Optional Capabilities”), which are described below.
Differences between capabilities available to our enterprise, mid-market and strategic customers are specified below. Unless otherwise specified, capabilities are included in both our enterprise and mid-market offerings.
UltiPro's Standard HR/Payroll Functionality
UltiPro can act as the gateway to business activities for a company's executives, management team, HR/payroll staff, administrators, and employees. Employees of customers can access UltiPro from standard web browsers such as Microsoft Internet Explorer, Mozilla Firefox and Google Chrome, view information and perform tasks in a language of their individual choice (most commonly English, Spanish, or French), set their personal preferences for the order and placement of home-page content, and set up access to any available page in one click. Ultimate believes that UltiPro allows our customers to improve service to their employees through better communications and to save time because managers and administrators can complete hundreds of common employee-related tasks, including administering benefits, managing staff and accessing reporting and business intelligence in real time, from one central solution. UltiPro also enables companies to provide secure, on-demand access to company and personal information for their employees over the Internet.
UltiPro's Standard HR/payroll functionality includes, but is not limited to, the following:
Human Resources Management. UltiPro manages all aspects of a person and their employment relationship regardless of where the employee resides. This includes personal details, skills and competencies, international identification documents, employment history, employment contracts (for those employees in countries that require them), performance, job and salary information, career development and preferences, and health and wellness programs. This allows single country or multinational organizations to easily manage and report on worldwide headcounts, and other critical business metrics. In addition, UltiPro facilitates the recording and tracking of key information for government compliance and reporting in the US, Canada and many other countries. This includes the Consolidated Omnibus Budget Reconciliation Act (COBRA), the Health Insurance Portability & Accountability Act (HIPAA), regulations implemented by the Occupational Safety & Health Administration (OSHA), workers' compensation regulations, the Family Medical Leave Act (FMLA), the ACA (Affordable Care Act), and Equal Employment Opportunity (EEO) laws for the United States. UltiPro also enables compliance with HIPPAA confidentiality requirements for protecting sensitive data such as employee social security numbers.
Benefits Management. UltiPro allows companies to automate the administration of health, welfare, dental, vision, and other benefits they offer their employees, including configuration and the matching of employee and employer contributions. UltiPro also enables employees to check benefit options and coverage online. UltiPro eliminates the need for duplicate rules, duplicate data entry, and reconciliation reporting because it stores details for deductions and benefit plans in one common table. These features include rules for coverage, premium and employer match computations, and eligibility and participation determinations. UltiPro also allows companies to maintain and administer paid time off allowances (including vacation, sick, and holiday accrual computations), track leave-time taken, and facilitate the response to employee leave requests.
Payroll. UltiPro's payroll features a powerful engine that handles hundreds of payroll-related computations intended to minimize the customer's need for side calculations or additional programming. UltiPro delivers complex wage calculations such as average pay rates for overtime calculations, shift premiums, garnishments and levy calculations. With UltiPro, a company's central payroll department, remote offices or multiple divisions can process payroll and can define and report on who completes each specific processing step based on the exact needs of the organization, thus supporting appropriate segregation of duties. All of this is managed through an easy-to-use dashboard of payroll tasks and statuses. To help our customers reduce the complexities and errors associated with administrators manually assigning appropriate payroll taxes to employees in the United States, Ultimate offers an embedded feature called Smart Tax Search™. Smart Tax Search™ leverages the latest GIS (geographic information systems) technology to enable UltiPro to automatically assign the correct federal, state, and local payroll taxation rules based upon the home and work addresses listed in UltiPro’s employee records.
Tablet-Based Time clock. UltiPro TouchBase, which was introduced in connection with our acquisition of Employtouch (the "Employtouch Acquisition"), provides our customers an interactive mobile time clock device that collects time punches, as well as highlights the information most critical to employees and managers via an engaging activity stream. With UltiPro TouchBase, our customers can capture employee time on a touchscreen tablet device, collecting employee-validated data for cost accounting and payroll; can leverage photos for accurate capture of employee time-entry, avoiding

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'buddy punches'; and can validate transactions using PIN (Personal Identification Number) entry, HID (Human Interface Device), RFID (Radio Frequency Identification), magnetic swipe or barcode.
Role-Based Self-Service. Authorized managers have self-service access to staff information such as salary, compensation history, key dates and emergency contacts, with reporting and workforce analysis tools to facilitate decision-making. A customer's managers can view and update staff information, manage department activities, post job openings, leverage recruiting and hiring tools, and perform queries on workforce data. UltiPro's document management features can be used to house and categorize employee-related documents such as drivers' licenses, consent forms, and completed I-9 forms with required identification. Administrators, managers and employees have the ability to attach files in standard formats such as Microsoft Word, PDF, JPEG, and spreadsheets to employee files. The documents can be grouped and sorted to individual requirements, as necessary.
Employees also may be given immediate, security-protected access to view their own pay details on a mobile device or the web, and benefits summaries, frequently used forms, and company information on the web. They can also update personal information such as address, phone number, emergency contacts, and skills; change their preferences such as direct deposit accounts and benefits selections; make routine requests such as asking for vacation time; and enroll in training.
UltiPro Business Intelligence. UltiPro Business Intelligence leverages a business intelligence platform from IBM Cognos Corporation, a third-party provider, for built-in, ad hoc HR, payroll, and talent management reporting and analysis. Accessed via the web and mobile, UltiPro Business Intelligence gives users the ability to access data across the UltiPro solution—from HR and payroll to benefits administration and enrollment, compensation, talent acquisition and onboarding, talent management, compliance, year-end data, and more—and enables them to create, modify, and distribute workforce-related reports and automated notifications. UltiPro also includes a pre-configured data mapping library and pre-authored reports and analytics. Controlled by role-based security, everyone in a customer's organization—from line managers to executives—can have immediate access to key workforce metrics, and they can personalize their own user experience to show the reports they want to see and how they want to see them. We believe that UltiPro Business Intelligence gives our customers significant strategic value for managing their workforce-related functions and saves them labor time and money by eliminating or reducing the need for internal technology resources to generate hundreds of individual reports for disparate executive and management needs. UltiPro Business Intelligence is available to manager roles on a mobile device or tablet to provide quick access to mobile optimized reports and analytics. We also embed key data insights and visualizations in context of the application. These data visualizations are developed as part of the core application and provide in-context support to decision-makers.
Other Key Capabilities. UltiPro's tracking of hours worked in payroll ties to UltiPro's benefits management, enabling automatic calculation of employees' hours of service eligibility and providing HR leaders analytical insight into compliance risk related to the ACA delivered via a Healthcare Eligibility Dashboard and our UltiPro ACA Toolkit. UltiPro includes capabilities for consent, data erasure, data portability, access and rectification, which allow organizations that store or process personal information of EU residents to comply with the General Data Protection Regulation (GDPR). UltiPro includes system configuration tools such as graphical workflow configuration and platform configuration to allow customers to extend UltiPro with secure, personalized and reportable fields. Conditional workflow enables organizations to authorize HR/payroll staff, managers, or supervisors to manage key HR processes with multiple approvals via UltiPro, expediting business activities such as hiring an employee or making a salary increase. UltiPro workflow is configurable based on customer need and includes numerous pre-configured processes based on industry best-practices. In addition, UltiPro offers role-based security, flexible business rules, and an easy-to-use content management tool. System administration is designed to enable non-technical users to administer UltiPro's role-based security, built-in conditional workflow, and system business rules, as well as to enable system administrators to post company communications, link to external web sites and tailor functionality to reflect the customer's own company user experience requirements. Broadcast communications tools are available and can leverage employee qualifiers in UltiPro for distribution of mass communication emails to ensure accurate recipients and the trackable follow-up and/or acknowledgment often required with regulated notifications. Enterprise Integration Tools also are included to provide the ability to interface with third-party cloud and on-premise applications and providers such as general ledger, payment services, time clocks, banks, 401(k) and benefits providers, check printing services and unemployment management services. Delivered integrations are also available to customers through UltiPro Connect and the UltiPro Developer Network of preferred partners to facilitate extending their UltiPro and third-party data across multiple systems.
UltiPro Predictors. The UltiPro predictive analytics solution is a key part of the core UltiPro suite where predictive metrics and indicators are available to support manager decisions. The predictors are based on statistical algorithms we developed, refined, and validated with numerous customers. UltiPro’s predictive analytics help managers to determine the best actions to take for further developing or changing the career trajectory of employees reporting to them, thereby helping organizations to reduce turnover and improve employee engagement. For example, organizations can set tolerances for certain predictive metrics in our UltiPro Retention Predictor, giving a manager or HR generalist the ability to see immediately if an employee exceeds the tolerance level they have defined as "at risk of leaving" and, thereby, providing

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them an early warning to take an appropriate action to increase the chances of that employee staying. In addition to our UltiPro Retention Predictor, the solution includes an UltiPro High Performer Indicator™, which identifies employees who consistently receive high pay raises, and an UltiPro High Performer Predictor™, which ranks employees predicted to be high performers based upon a number of variables tracked in UltiPro, and the UltiPro Engagement Indicator which provides insight into an employee’s level of engagement at their organization. To assist managers in identifying and tracking key actions designed to increase the engagement and retention of team members, UltiPro Leadership Actions prompt a leader to intervene in a positive and proven-to-be effective fashion, based on best practices in talent management. UltiPro Recruiting’s Candidate Match feature analyzes multiple aspects of incoming candidates and the positions they have applied for to provide insights around a candidate’s potential fit for a position, thereby helping recruiters and hiring managers to focus talent searches and identify appropriate opportunities for qualified applicants.
UltiPro's Optional Capabilities
UltiPro Talent Acquisition is a suite of add-on products comprised of Recruitment and Onboarding.
i) Recruiting. The Ultimate team designed our recruiting solution to transform the recruiting process by increasing candidate engagement and simplifying the work of recruiters. Built to be candidate-centric, UltiPro Recruiting has a consumer-like interface to attract and keep top talent engaged, with the goal to reduce the typical 40 percent to 80 percent online application drop-off rate typically occurring with traditional applicant tracking solutions. Rather than being restricted to limited profile information and résumés typical of traditional solutions, candidates can build an in-depth online presence that gives recruiters and hiring managers a more complete understanding of who they are and their abilities. UltiPro Recruiting includes an appealing user interface, gamification, and collaboration tools. It is fully mobile and integrates with popular social networks such as LinkedIn and Twitter. At the same time, UltiPro Recruiting automates the recruiting process for hiring managers, recruiters, and HR staff by enabling them to track and manage standard recruitment tasks such as posting open jobs, reviewing résumés, screening candidates, and scheduling interviews.
ii) Onboarding. UltiPro Onboarding is a comprehensive solution that provides employers the ability to engage and welcome new employees into an organization before the first day of work and to speed their time to productivity. UltiPro Onboarding enables dynamic content such as video messages from executives, managers, and co-workers and gives new hires the ability to connect with fellow team members, request a mentor, engage in self-directed learning through a feature called ‘Unlock Your Potential,’ and complete required and compliance-related documents. The solution is easily configurable to meet the specific needs of an organization and includes such activities as obtaining required government and procedural paperwork, including electronic signatures and document storage; provisioning necessary equipment and job-specific tools such as office location, computer equipment, and uniforms; ensuring enrollment in necessary training programs; and familiarizing new hires with the employer's core values and business objectives.
UltiPro Talent Management is a suite of add-on products comprised of Performance Management, Talent Predictors, and Succession Management.
i) Performance Management. UltiPro Performance Management helps companies maximize the development of their people and improve employee satisfaction by automating and enhancing the performance process, using competency-based employee development. UltiPro Performance Management streamlines the processes of evaluating performance and completing performance reviews, validating competencies, identifying top performers for succession planning, and tracking and executing coaching, training and development plans. The solution also supports a continuous process of capturing real-time employee feedback from a social network and, through our mobile solution, makes goal management and access to talent profile information, employee observations, and journaling convenient for employees and managers alike.
ii) UltiPro’s Talent Predictors are predictive analytics tools that help organizations to evaluate their talented people more proactively and objectively by providing them meaningful, unbiased metrics. Our predictive analytics include:  UltiPro Retention Predictor, which forecasts an employee’s likelihood of staying with the organization for the next 12 months; UltiPro High Performer Indicator, which helps leaders to identify who top performers are in their organization; and UltiPro High Performer Predictor, which identifies which employees have the likelihood of becoming high performers in the future.

iii) Succession Management. With UltiPro Succession Management, organizations can involve company leadership, managers, and individuals in an ongoing, collaborative process of succession planning. Employees can manage their own talent profiles-updating factors that influence succession readiness such as mobility preferences,

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languages, education, accomplishments, and competencies-to ensure that leadership has a deeper understanding of the talent landscape at their organization. Visible to employees and managers, UltiPro's employee “talent card” provides a consolidated and comparative view of multiple succession-readiness factors, which then can be used in both decision-making and career development processes.
Other Optional Capabilities include, but are not limited to, the following products, which are supplemental to UltiPro's standard HR/payroll capabilities:
UltiPro Learning. Through a strategic partnership, Ultimate has the right to market and distribute an independent third party's learning management product as part of the UltiPro solution. We have branded this product UltiPro Learning. Ultimate is the single-source contact for customer implementations and ongoing solution support for UltiPro Learning. It is both web-based and mobile and is integrated with UltiPro's HR and talent management functionality. UltiPro Learning is a new approach to learning that supports the collaborative and on-demand nature of learning demanded by employees today. UltiPro Learning allows organizations to create, curate, and deliver learning content to employees and other members of the extended enterprise to meet their professional and personal learning needs. Customers can also create learning academies to meet specific organizational needs.
UltiPro Perception. UltiPro Perception was introduced as part of the acquisition, made in the third quarter of 2016, of Kanjoya, Inc. ("Kanjoya"), a California corporation (the “Kanjoya Acquisition”), located in San Francisco, California. UltiPro Perception offers a modern way to collect and understand feedback through employee surveys and in-depth analytics of that data for HR and managers. The solution enables organizations to solicit feedback from employees in both structured and unstructured forms. Using the power of the ingrained Natural Language Processing (NLP) engine, UltiPro Perception analyzes feedback in a variety of ways, providing leaders a deeper understanding of employee sentiment while safeguarding employee privacy and anonymity. The built-in analytics allow everyone from HR and company executives to individual managers to view and gain a deeper insight into employee sentiments, identify employee feedback trends, and compare team results. These insights provide the basis for organizations to take appropriate action tailored to the needs of both teams and leaders, with the objective to improve engagement, satisfaction, and retention.
UltiPro Compensation Management. UltiPro Compensation Management includes Salary Planning, Salary Budgeting and Incentive Compensation Plans capabilities. This expanded solution is designed to support executives, managers and compensation analysts working with salary increase allocations and to incentivize employees by giving them visibility into their individual compensation plans. Highly configurable, including multi-currency and pro-ration capabilities, UltiPro Compensation Management makes it easy for companies to manage their unique compensation plans and salary award processes with flat amounts, percentages and unit-based compensation such as restricted stock unit awards. Managers can review their salary budgets and merit pool guidelines and determine the best way to allocate pay increases to their employees within their approved budget parameters. Once managers decide on the allocations, the related pay increases and awards are automatically submitted, approved and updated to UltiPro Payroll.
UltiPro Benefits Enrollment. With UltiPro Benefits Enrollment, employees can enroll in the appropriate benefit plans for their individual needs online, either at work or from home, during defined open enrollment periods. Employees can also choose to quickly renew their benefits in a single click and are guided to make the right selections based on prerequisites that link benefit plans together. UltiPro mobile capabilities enable employees to update their retirement contributions on the go. Benefits administrators can configure the enrollment process and messaging to make the process easy for employees and can monitor the enrollment progress. UltiPro Benefits Enrollment also guides employees through the benefit and personal information changes necessary as a result of life events such as getting married, having a baby or moving. UltiPro also delivers more than 70 predefined Benefit Carrier templates to facilitate the electronic feeds required for insurance carriers and plan administrators, reducing the need for manual reporting of employee census information, participant coverage, and billing reconciliation.
UltiPro Benefits Prime. Ultimate has the right to market and distribute an independent third party's benefit administration, decision support, and enrollment product as part of our UltiPro solution. We have branded this product UltiPro Benefits Prime. Benefits Prime serves as an optional advanced benefit solution that focuses on simplifying the administration of complex plan rules and improving the employee enrollment experience. Through in-depth education and personalized recommendations, UltiPro Benefits Prime helps employees better understand the benefits options available to them. With an easy-to-navigate solution, robust tools for administrators, and connections with hundreds of carriers, UltiPro Benefits Prime delivers consumer-grade benefits shopping and decision-support capabilities for an organization’s employees, along with advanced benefits billing, compliance, reporting and ongoing support for the benefits administrator. Organizations can configure the solution to support diverse programs, automate processes, ensure compliance, and engage employees. Ultimate is the single-source contact for customer implementations and ongoing solution support for UltiPro Benefits Prime, and it is integrated with core UltiPro HR and Payroll capabilities.

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UltiPro Time, Attendance, and Scheduling (designed for enterprise companies). Through a strategic partnership, we have the right to market and distribute an independent third party's time and labor management product as part of the UltiPro solution. We have branded this product as UltiPro Time and Attendance, marketing the components as UltiPro Time and Attendance, UltiPro Leave Management, and UltiPro Workforce Scheduling (collectively, “UTA”). Ultimate is the single-source contact for customer implementations and ongoing solution support for UTA. UTA is web-based and integrated with UltiPro's payroll, HR, and benefits functionality. UltiPro Time and Attendance tracks time and attendance labor metrics and supports a variety of time-capture mechanisms. UltiPro Leave Management includes all of the functionality required to effectively track and manage employee leave. UltiPro Workforce Scheduling features industry-specific employee scheduling options to ensure that organizations in different environments deploy employees in an efficient and legislatively compliant manner.
UltiPro Time Management (designed for mid-market and strategic companies). UltiPro Time Management delivers the functionality and flexibility needed to manage employee time and attendance efficiently and provides web access to real-time employee time and labor information. UltiPro Time Management provides companies with the tools to proactively prevent issues that negatively impact business performance, such as employee coverage gaps, labor law violations, and excess labor spending. Fully integrated scheduling, time and attendance, and leave management capabilities reduce payroll expenditures and streamline payroll and workforce management processes.
UltiPro Workforce Management. The UltiPro Workforce Management suite is a limited release of UltiPro Time and UltiPro Scheduling applications, which was new in 2017. It is fully integrated with UltiPro Payroll and is designed to deliver a relatively effortless experience for time tracking and scheduling for employees at every level. The solution reduces the need for supportive resources; increases visibility into time off, allowances, and work schedules; and elevates the convenience of time tracking through features such as mobile access and in-app messaging between managers and employees. UltiPro Workforce Management removes the demands and roadblocks of traditional labor management systems by requiring minimal human interactions and proactively presenting relevant information to enable employees to quickly manage their own time and schedules.
UltiPro Payment Services. With UltiPro Payment Services solution, companies are able to meet all Federal, state, and local payroll tax filing obligations quickly and easily. The UltiPro solution saves payroll staff time by eliminating the administrative burdens associated with tax filing. UltiPro Payment Services enables businesses to deposit federal, state, and local tax payments for more than 10,000 active tax codes via electronic funds transfer or check and automates filing for monthly, quarterly, and annual tax returns.
UltiPro Wage Attachments. For organizations required to process third-party payments on behalf of their employees for items such as child support, tax levies, and creditor garnishments, UltiPro Wage Attachments provides the means to effectively streamline and manage the payment process. UltiPro Wage Attachments eliminates the burden associated with payments to third parties by using information entered and calculated in UltiPro, so there is no need to manage payment processing or analyze varying disbursement schedules for multiple jurisdictions. We ensure that each third-party payment is made according to the designated payment method and reaches its required destination within the assigned timeframe.
Patient Protection and Affordable Care Act (ACA) Compliance. In the fall of 2015, Ultimate began deploying an ACA Toolkit that enables our customers to comply with ACA regulations by the 2016 deadline. The toolkit is embedded in UltiPro and automatically populates the Forms 1094-C and 1095-C with the appropriate employee, benefits, and organization information. In addition, Ultimate offers our customers additional optional ACA-related services branded UltiPro ACA Employer Services. These include such services as printing and electronic filing of 1094-C and 1095-C forms with the IRS on our customer’s behalf and ongoing proactive monitoring and managing of employee eligibility alerts, notices, and penalty responses.
UltiPro HR Service Delivery is suite of products for organizations to manage their HR service operations and communications while delivering content in context to employees and managers. UltiPro File Management and UltiPro Case Management are being introduced to Ultimate’s customers as a result of Ultimate’s acquisition of PeopleDoc made in the third quarter of 2018. Headquartered in Paris, France, PeopleDoc is a respected pioneer in HR Service Delivery.
UltiPro File Management. UltiPro Employee File Management makes it simple and convenient for HR team members to actively manage employee files, giving them the ability to create, access, share, or delete files at any time, from anywhere. New documents generated as part of an HR process or employee request are automatically sent to the correct employee file and can be accessed on demand. HR departments can easily reduce compliance risks with this solution’s ability to define retention schedules by document type and geography, provide reports on missing or expiring documents, and protect sensitive information with role-based access.

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UltiPro Case Management. UltiPro Employee Case Management helps employees acquire the information and assistance they need from HR via a personalized knowledgebase or by submitting requests that are automatically routed to the appropriate HR team member for answering. Employees can search for and find answers to their HR-related questions at any time and from anywhere. HR can track and report on key metrics and monitor key performance indicators for insight into this HR service experience. Since requests submitted to HR by employees are automatically tracked and routed based on configurable, predefined workflows, organizations save time, increase efficiency, and deliver a better, more consistent employee experience.

Other Optional Capabilities. We offer a number of additional HR and payroll-related services to extend the value of UltiPro, including test environment services, W-2 print services, pre-employment screening, paycheck modeling, pay cards, unemployment tax management, employment verification services, employee assistance, health and wellness, and work/life balance programs. In addition, we offer UltiPro Federated Single Sign-On for standards-based identity management by leveraging Microsoft's Active Directory Federated Services infrastructure as well as single-sign-on capabilities through our partner Ping Identity. These solutions help improve and simplify data security by enabling individuals to use a single login credential (such as a network login) to seamlessly access UltiPro over the Internet.
Technology
We strive to use the most modern and capable technologies available for delivering solutions that are flexible, easy to use, fast, and secure. Major characteristics of our cloud application platform include, but are not limited to, the following:
Multi-tenancy. As a SaaS provider, we use a multi-tenant cloud model that allows us to support multiple customers on a single set of systems while maintaining performance, security, and reliability. We manage and maintain our solutions for our customers, including all hardware and software upgrades. Our customers benefit by reducing their need to keep their own IT resources on staff for UltiPro solutions. Our cloud customers also benefit from having the most current version of UltiPro installed as soon as it is available.
Configurability. We have invested in our own technology and approaches for enabling application and system configurability, giving our customers the ability to achieve a highly tailored solution while minimizing or eliminating the need to create custom code.
Openness and Connectivity. We leverage widely adopted technology and industry standards for exposing data and functionality via application programming interfaces (APIs). Customers can access their HCM data based on these standard, open, and secured connections in order to link to their in-house systems, third-party cloud applications, and other systems that require data feeds such as benefits providers. Our UltiPro Carrier Network (UCN) leverages industry-leading solutions, allowing Ultimate to create standard, reusable connectors that support the unique data transfer requirements of individual benefits providers, simplifying both the development and maintenance of these connections. Ultimate also supports a number of partner integrations developed through our UltiPro Developer Network (UDN) and packaged connectors for solutions that expand or extend the functionality included in UltiPro. These packaged integrations include, but are not limited to: Yammer, a provider of enterprise social networking solutions; CERTPOINT, a provider of learning management solutions; and Ping Identity, which offers single-sign-on capabilities for business applications.
Domain-Driven, User-Centered Design. Our solution design approach includes domain-driven design, which provides a streamlined process for developing software with the complexities of an HCM domain in alignment with the principles of a service-oriented microservices architecture. A key focus of our user-centered design is to optimize the overall user experience of our customers and to maximize user engagement. We have invested significant resources in usability design and testing to create a consumer-grade experience that is flexible, responsive, and personalized. In the design of the user-experience, our emphasis is on how users want to use the product rather than the expectation that users will change their behavior to accommodate the product.
Omni-Channel User Experience. In addition to the user experience capabilities available through UltiPro’s web experience, the UltiPro mobile application available for iOS and Android devices provides employee and manager functions through native mobile interactions. Additionally, interactive capability-based functions are now available through a more conversational interface using UltiPro’s Slack integration.
Workflow. Ultimate supports numerous transactions and operational processes for our customers. These processes are frequently unique to an individual customer and typically require multiple steps, approvals, data input, and confirmations. To support our customers' unique requirements, UltiPro includes configurable business process automation, or workflow, which enables customers to automate processes based on their own needs and change these processes over time without custom software code.

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Business Intelligence. Ultimate provides sophisticated data query and report authoring via IBM Cognos, a leading suite of business intelligence tools. Our customers can access reports and conduct data queries from a web browser and are able to apply on-line analytical processing to multidimensional data cubes for exploring data on employees graphically and statistically from diverse angles. We maintain a link between Cognos' report catalog and UltiPro's data dictionary, eliminating the necessity for customers to create and maintain ad hoc reporting catalogs on their own. We also maintain a BI Exchange, an online community where Ultimate professionals and customers can post, download, and share standard reports. We have unified security for the data elements across UltiPro and Cognos instances so that role-based security controls data access across both solutions. We also provide single sign-on to simplify and secure user access.
Data Centers for Cloud Offering
Our cloud offering provides web-based access to comprehensive HCM functionality for organizations that want to simplify delivery and support of their business applications. As a part of our cloud offering services, Ultimate provides the hardware, infrastructure, ongoing maintenance and backup services for our customers at eight data centers. The data center located near Atlanta, Georgia, is owned and operated by Quality Technology Services (“QTS”). The data centers located near Toronto and Vancouver, Canada, are owned and operated by Cyxtera Technologies ("Cyxtera") (formerly CenturyLink Technology Services ("CenturyLink") ). The data center located in Phoenix, Arizona, is owned and operated by Iron Mountain Data Centers, LLC (formerly IO Phoenix One, LLC). After the PeopleDoc acquisition, Ultimate also provides services to our customers at data centers (located near Ashburn, Virginia, Dallas, Texas, and Frankfurt, Germany), which are owned and operated by Rackspace US, Inc. (“Rackspace”) and a data center located near Paris, France which is owned and operated by Ecritel France (“Ecritel”).
Ultimate's use of the data center located near Atlanta, Georgia, is governed by a Master Space Agreement dated February 2, 2012 with Quality Technology Services Metro, LLC (“QTS Metro”). Pursuant to the terms of the QTS Agreement, Ultimate may from time to time submit orders for the use of certain physical space within the data centers for hosting Ultimate's hardware equipment, as well as Internet connectivity services, security, power and generator back-up, environmental controls and access controls. The QTS Agreement provides that any service order will automatically renew for successive renewal terms, unless either party notifies the other party in writing at least sixty days prior to the end of the then current term that there will be no such renewal. Furthermore, the QTS Agreement may be terminated at any time by either party thereto, if: (i) the non-terminating party breaches any material term of such QTS Agreement and fails to cure such breach within 10 days after receipt of written notice; (ii) the non-terminating party becomes the subject of a voluntary or involuntary proceeding relating to insolvency, bankruptcy, receivership, liquidation, or reorganization; or (iii) a court or other government authority having jurisdiction over the services prohibits the furnishing of services governed by such QTS Agreement.
Ultimate's use of the data centers located near Toronto and Vancouver, Canada, are governed by a Master Services Agreement dated April 30, 2013 (the “CenturyLink Agreement,” now known as Cyxtera) between Ultimate's wholly owned subsidiary Ultimate Canada and CenturyLink. Pursuant to the terms of the CenturyLink Agreement, Ultimate Canada has use of certain physical space within the data center for hosting Ultimate Canada's hardware equipment, as well as Internet connectivity services. The CenturyLink Agreement contains provisions relating to data security and access to the data center. Upon placing a service order, Ultimate Canada is guaranteed certain pricing terms and is committed to minimum usage levels for a period of at least 36 months from the effective date of April 1, 2016, per an addendum entered into by both parties to extend the term of the original agreement. The CenturyLink Agreement will renew on a month-to-month basis unless either party gives at least sixty days written notice prior to the completion of the applicable term that there will be no such renewal. The CenturyLink Agreement provides that its term will end upon the expiration of the term of the last-executed service order. Ultimate has guaranteed the payment of all amounts due from Ultimate Canada to CenturyLink under the CenturyLink Agreement.
Ultimate's use of the data center located near Phoenix, Arizona is governed by a License and Master Services Agreement dated February 27, 2012 (the "IO Phoenix Agreement,") with Iron Mountain Data Centers, LLC (formerly IO Phoenix One, LLC). Pursuant to the terms of the IO Phoenix Agreement, Ultimate has use of certain physical space within the data center for hosting Ultimate's hardware equipment, as well as Internet connectivity services. The IO Phoenix Agreement contains provisions relating to data security and access to the data center. Ultimate is guaranteed certain pricing terms through the initial term of the agreement and is committed to minimum usage levels for a period of at least 42 months from November 1, 2014, the effective date of an addendum entered into by both parties to extend the term of the original agreement. The IO Phoenix Agreement will automatically renew thereafter for additional terms of one year unless either party gives written notice prior to the completion of the applicable term that there will be no such renewal. Ultimate must give written notice within 60 days while IO Phoenix must give written notice within 120 days.
Pricing

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Our cloud offering is designed to provide an appealing pricing structure to organizations that prefer to minimize the initial cash outlay associated with typical capital expenditures for traditional on-premise products. Our cloud customers purchase the right to use UltiPro on an ongoing basis for a specific term in a shared or dedicated hosted environment, and the arrangement can typically be renewed after its initial term has expired. In the shared environment, Ultimate provides an infrastructure with servers shared among many customers who use a web browser to access the application software through the related data center. In the dedicated environment, the customer does not share servers with other customers but rather has its own set of servers. The pricing for our cloud offering, including both the hosting element as well as the right to use UltiPro, is on a per employee per month ("PEPM") basis.
Customer Services
Ultimate’s customer services department has a history of being recognized by third-parties for excellence. In 2018, Customer Sales and Services World Awards named Ultimate Customer Service Department of the Year, a Gold winner. At the same time, Ultimate also earned a Silver Stevie Award for Customer Service Department of the Year. In 2017, the National Customer Service Association named Ultimate’s services team the Service Organization of the Year in the large business category, the Innovation Award Network Products Guide named Ultimate’s team the Best Customer Service Department of the Year, and Stevie Awards honored our team with a People’s Choice Award for Favorite Customer Service in the Computer Services category. In 2016, the Technology Services Industry Association recognized our services team for “Innovation in Transformation of Support Services” in its TSIA Star Awards.

We believe that our focus on delivering our customers a positive and productive UltiPro experience has differentiated Ultimate in the marketplace and is critical to the quality of Ultimate's comprehensive service solution. We provide our customer services in two broad categories: (i) professional services and (ii) customer support services and product maintenance. Additionally, we provide services associated with the delivery of our cloud-based solutions. These services include, but are not limited to, purchasing and supporting hardware and system software; installing new versions of UltiPro; and backing up customer data.
Professional Services. Ultimate's professional services include system setup and launch (i.e., implementation), executive relationship management (“ERM”), and knowledge management (or training) services. We believe that our setup and launch consulting services are differentiated from those of other vendors by speed, predictability and completeness. Our successful record with rapid solution launches for our customers is due, we believe, to our standardized methodology, consultants, highly configurable product functionality, and comprehensive conversion and integration tools.
Ultimate has a primarily long-tenured team of functional and technical consultants who are dedicated to assisting customers with rapid deployments. In addition, we provide our customers with the opportunity to participate in formal training programs conducted by our learning team (on-site and virtual), including online self-paced courses, "Quick Tours," and on-demand training. Training programs are designed to increase our customers' ability to use the full functionality of our products, thereby maximizing the value of our customers' investments. Courses are designed to align with the stages of product launch and to give attendees hands-on experience with UltiPro. Trainees learn such basics as how to enter new employee information, set up benefit plans and generate standard reports, as well as more complex processes such as defining company rules, configuring the system and creating custom reports. Ultimate maintains training facilities in Atlanta, Georgia; Schaumburg, Illinois; Santa Ana, California; and at our headquarters in Weston, Florida. Ultimate rents training facilities in other locations, such as Dallas, Texas; Toronto, Canada; Montreal, Canada; Vancouver, Canada; and other cities on an as-needed basis. After our customers have processed their first live payroll using UltiPro (referred to as going “Live”) and have been turned over to our customer support and maintenance program, we assign a customer relationship manager to the account to assist customers obtaining maximum value of the UltiPro solution, connect with other Ultimate users and advanced business analytics. The ERM team also focuses a large portion of its time on customer retention, which is an important aspect of Ultimate's long-term business model.
Customer Support. We offer comprehensive and on-going support services to all our UltiPro customers. Ultimate had a recurring-revenue, customer-retention rate of approximately 96% in 2018. Ultimate's customer support services include: software updates that reflect tax and other legislative changes; a named customer service representative; telephone support 24 hours a day, 7 days a week; unlimited access to Ultimate's employee tax center on the web; seminars on year-end closing procedures; a customer blog; and periodic newswire emails. In addition, our customer support services team maintains a Customer Success Portal for our customers where customers can submit inquiries and service requests as well as search a knowledge base of information for instant answers to questions, holds an annual national user conference and arranges for Ultimate professionals to attend smaller, user-organized user group meetings on a routine basis throughout the United States.
Customers

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As of December 31, 2018, Ultimate provides our solutions to more than 5,600 customers, and we have more than 48 million people records in our cloud, including the customers and people records we added with the PeopleDoc acquisition. Ultimate's customers represent a wide variety of industries, including manufacturing, food services, sports, technology, finance, insurance, retail, real estate, transportation, communications, healthcare and other services. For each of the three years ended December 31, 2018, no customer accounted for more than 10% of our total revenues.
Sales and Marketing
We market and sell our products and services primarily through our direct sales force.
Our direct sales force includes business development vice presidents, directors and managers who have defined territories, typically geographic. The sales cycle begins with a sales lead generated through a national, corporate marketing campaign or a territory-based activity. In one or more on-site visits, phone-based sales calls, or web demonstrations, sales managers work with application and technical sales consultants to analyze prospective client needs, demonstrate Ultimate's UltiPro solutions and, when required, respond to requests for proposals. The sale is finalized after customers complete their internal sign-off procedures and the terms of the contract are negotiated and signed.
With a sale of the cloud offering, the agreement generally requires PEPM fees based on company size, and bundled fees for implementation and training. Typical payment terms include a deposit at the time the contract is signed and ongoing PEPM payments on specific payment dates designated in the contract, usually tied to the Live date.
We support our sales force with a comprehensive marketing program that includes public relations, advertising, direct mail, trade shows, seminars and workshops, email marketing, social media marketing, and web marketing. Working closely with the direct sales force, customers and strategic partners, our marketing team defines positioning strategies and develops a well-defined plan for implementing these strategies. Our marketing services include market surveys and research, overall campaign management, creative development, demand generation, results analysis, and communications with field offices, customers, and marketing partners.
Intellectual Property Rights
Ultimate's success is dependent, in part, on our ability to protect our proprietary technology. We rely on a combination of copyright, trademark and trade secret laws, as well as confidentiality agreements and licensing arrangements, to establish and protect our proprietary rights. We do not have any patents or patent applications pending.
Competition
The market for our products is highly competitive. Our products compete primarily on the basis of technology, delivered functionality, price/performance and service.
Ultimate's competitors in our enterprise market include (i) large service bureaus, primarily Automatic Data Processing Inc. (“ADP”) and, to a lesser extent, Ceridian; and (ii) companies, such as Oracle, Lawson, and Workday that offer human resource management and payroll software products for use on mainframes, client/server environments and/or in the cloud. In our mid-market and strategic market, Ultimate's competitors include primarily payroll service providers, such as ADP, Paychex, Ceridian, Paycom and Paylocity.
Backlog
Backlog consists of our UltiPro cloud-based solutions under signed contracts for which the services have not yet been delivered. Our backlog amounts include the full contract value of sales to our customers that have not yet processed their first payroll using UltiPro and are not indicative of the annual recurring revenue value of such sales. Backlog can vary from one year to the next when the average contract period fluctuates significantly. At December 31, 2018, Ultimate had backlog of $522.1 million compared with $456.2 million as of December 31, 2017. Ultimate expects to fill approximately $441.7 million of the backlog during 2019. Ultimate does not believe that backlog is a meaningful indicator of sales that can be expected for any future period. There can be no assurance that backlog at any point in time will translate into revenue in any subsequent period.
Employees
As of December 31, 2018, Ultimate employed 5,113 people, including the employees we added with the PeopleDoc acquisition. Ultimate believes that our leadership's relationships with employees are good. This belief is validated by Ultimate’s #1 ranking in the large company category of Fortune magazine’s 2018 and 2019 lists of Best Workplaces in Technology, our fourth consecutive year to be recognized as #1, and Ultimate's #3 ranking on Fortune's 2018 list of 100 Best Companies to Work

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For, our seventh year to be ranked in the top 15, as well as our #3 ranking on People magazine's 2018 list of Companies That Care. Also in 2018 Fortune ranked Ultimate #1 on its list of 100 Best Workplaces for Women and #1 on its list of 100 Best Workplaces for Millennials, Ultimate's second year to earn the top spot. Ultimate has a history of good employee relationships as confirmed by consistently high ratings of our workplace culture by third parties over the years. In 2017, in addition to the multiple-year rankings noted above, Ultimate was ranked by Fortune magazine and Great Place to Work as: #2 on 100 Best Workplaces for Women, #3 on Best Workplaces for Diversity, #2 on 50 Best Workplaces for Parents, and #7 on 50 Best Workplaces for Giving Back. As far back as 2008 and 2009, when Ultimate was a smaller company, the Great Place to Work Institute ranked Ultimate the #1 Best Place to Work in America among medium-sized companies for both years. When Ultimate exceeded 1,000 employees in size and became eligible for Fortune’s large company lists, Fortune ranked Ultimate #25 on its 2012 100 Best Companies to Work For list, #9 on its 2013 list, #20 on its 2014 list, #21 on its 2015 list, and #15 on its 2016 list. However, we know competition for qualified employees in the technology sector and Ultimate's HCM industry, in particular, is intense. Ultimate’s management team recognizes that our future success will depend, in part, on our continued ability to attract, hire and retain qualified people.
Available Information
Ultimate's Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, proxy statements and amendments to those reports and any registration statements, including but not limited to registration statements on Form S-3, are available free of charge on Ultimate's website at www.ultimatesoftware.com as soon as reasonably practicable after such reports are electronically filed with the Securities and Exchange Commission (“SEC”). Information contained on or accessible through Ultimate's website is not part of this Form 10-K. The SEC maintains an Internet site that contains the reports, proxy and information statements and other information regarding us that we file with the SEC. You can access the SEC's website at www.sec.gov.
Ultimate operates in a rapidly changing and dynamic business environment that involves risk and uncertainty.  The following discussion is a description of risks and uncertainties associated with our business that could cause, or contribute to causing, actual results to differ materially from expectations.  These are not all of the risks we face.  We may be adversely affected by risks not currently known or that we currently consider immaterial.
The Merger is subject to various closing conditions and other risks which may cause the Merger to be delayed or not completed at all or have other adverse consequences.
The Merger is subject to various closing conditions that must be satisfied or waived to complete the Merger. There can be no assurance that these conditions will be satisfied or waived or that the Merger will be completed in a timely manner or at all. Failure to satisfy or obtain waivers of any closing condition may jeopardize or delay the completion of the Merger and result in additional expenditures of money and resources including, but not limited to, the adverse impact of a termination fee of up to $331 million payable by Ultimate under certain circumstances specified in the Merger Agreement. The Merger also is subject to approval by Ultimate’s stockholders. There is no assurance that Ultimate’s stockholders will approve the Merger. In addition, the Merger is contingent upon the receipt of certain regulatory clearances or approvals. There can be no assurance that the conditions to closing will be satisfied or waived or that other events will not intervene to delay or prevent the closing of the Merger. If the Merger is not completed for any reason, the price of our Common Stock may decline to the extent that the current market price reflects an assumption that the Merger will be consummated and our stockholders will not receive any payment for their shares in connection with the Merger. Instead, Ultimate would, in such case, remain an independent public company, and its shares will continue to be traded on the NASDAQ.
Legal proceedings instituted against Ultimate and others relating to the Merger Agreement also could delay or prevent the Merger from becoming effective within the agreed upon timeframe. In addition, we may elect to terminate the Merger Agreement in certain circumstances, and the parties can mutually decide to terminate the Merger Agreement at any time prior to the consummation of the Merger before or after stockholder approval. Further, uncertainty among our employees about their future roles after the completion of the Merger may impair our ability to attract, retain and motivate key personnel, and the pending finalization of the Merger may disrupt our business relationships with our existing and potential customers, suppliers, vendors, landlords, and other business partners, who may attempt to negotiate changes in existing business relationships or consider entering into business relationships with parties other than us. The adverse consequence of the pending finalization of the Merger could be exacerbated by any delays in completion of the Merger or termination of the Merger Agreement.
We have incurred, and will continue to incur, significant transaction and related costs in connection with the Merger.
We have incurred and expect to continue to incur a number of costs associated with completing the Merger. Such costs include the payment of certain fees and expenses incurred in connection with the Merger, including legal and other professional

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advisory fees. The substantial majority of these costs will be non-recurring expenses and will primarily consist of transaction costs related to the Merger. Additional unanticipated costs also may be incurred.
While the Merger Agreement is in effect, we are subject to restrictions on our business activities.
While the Merger Agreement is in effect, we are subject to restrictions on our business activities, including, among other things, restrictions on our ability to acquire other businesses and assets, dispose of our assets, make investments, enter into certain contracts, repurchase or issue securities, pay dividends, make capital expenditures, amend our organizational documents, incur indebtedness and settle litigation. These restrictions could prevent us from pursuing strategic business opportunities, taking actions with respect to our business that we may consider advantageous and responding effectively and/or timely to competitive pressures and industry developments, which may as a result materially adversely affect our business, results of operations and financial condition.
If the Merger Agreement is terminated, we may, under certain circumstances, be obligated to pay a termination fee to Parent and/or reimburse Parent for its expenses. These costs could require us to use cash that would have otherwise been available for other uses and/or incur debt to pay such fees.
If the Merger is not completed, in certain circumstances, we could be required to pay a termination fee of up to $331 million to Parent. If the Merger Agreement is terminated, and we are required to pay a termination fee, we may incur debt to pay such fees. For these and other reasons, termination of the Merger Agreement could materially adversely affect our business operations and financial results, which in turn would materially and adversely affect the price of our common stock.
Our failure to maintain and increase acceptance of UltiPro, which accounts for substantially all of our revenues, could cause a significant decline in our revenues.
Currently, the UltiPro solutions, including the UltiPro standard/HR payroll product and Optional Capabilities and related services, account for substantially all of our revenues. Our future success depends on maintaining and increasing acceptance of UltiPro. Any decrease in the demand for UltiPro would have a material adverse effect on our business, operating results and financial condition.
If we are unable to enhance our products and develop new services, our revenue growth may be harmed.
Our ability to attract new customers and increase revenue from existing customers will depend in large part on our ability to enhance and improve our existing UltiPro product suite and Optional Capabilities and to introduce new features and Optional Capabilities to our product offering. The success of any enhancement or new feature depends on several factors, including the timely completion, introduction and market acceptance of the enhancement or service. If we are unable to develop enhancements and introduce new features and Optional Capabilities to our existing products in a cost-effective manner that keeps pace with rapid technological developments, our business could be adversely affected. If we are unable to successfully develop, acquire new services or enhance our existing products to meet customer requirements, our revenues may not grow as expected.
Due to the method of accounting for sales from our cloud offering, a change in the period of the time from contract date to the Live date (“Time-to-Live”) could negatively impact the amount of recurring revenues recognized in a reporting period.
Sales production, as it pertains to sales of cloud units, is not reflected in recurring revenues and related variable costs in our consolidated statements of income typically until the related customer goes Live. In our internal business model, we make certain assumptions, among other things, with respect to future sales production, revenue growth, variable costs, personnel costs and other operating expenses.
Our expectations for recurring revenue growth are typically established based on combinations of actual sales production (for those units that have been previously sold but have not yet gone Live) and expected future sales production, together with expectations as to the Time-to-Live periods. Estimates for Time-to-Live periods are usually based on (i) specific estimates (for certain backlog sales) provided by our field personnel, which estimates include factors and assumptions that are not within the control of our field personnel; and (ii) estimates for Time-to-Live periods for other cloud sales (including backlog sales without specific estimates at that point in time), as well as expected sales, which are typically based on assumptions derived from our historical Time-to-Live periods.  These estimates are adjusted periodically, and prospectively, based on management’s assessment of Time-to-Live for backlog sales at that point in time. Factors that could impact the estimates for Time-to-Live periods include, but are not limited to, customer size (as larger customers may have longer implementations, tend to go Live on more UltiPro features and have more interface and integration requirements), and the number of complementary products sold in addition to UltiPro to a single customer, which in some cases involve customers’ desire to go Live on all products at once, as compared with UltiPro first followed by complementary products.

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To the extent there are changes in the underlying assumptions which drive Ultimate’s expected revenue growth from cloud sales, which include, but are not limited to, actual sales production achieved and changes in Time-to-Live periods, our recurring revenues and services revenues, as reported in our consolidated statements of income, could differ materially from levels we expected to achieve.
A systems failure or other service interruption at the data center owned and managed by QTS, the data centers owned and managed by Cyxtera (formerly known as CenturyLink), and the data center owned and managed by Iron Mountain Data Centers, LLC (formerly IO Phoenix One, LLC) and used for our hosting services could result in substantial expense to us, loss of customers and claims by our customers for damages caused by any losses they incur.
We offer hosting services, which include hardware, infrastructure, ongoing maintenance and back-up services, to our customers in the United States at a data center owned and operated by QTS, at a location near Atlanta, Georgia and at a data center owned and operated by Iron Mountain Data Centers, LLC (formerly IO Phoenix One, LLC) near Phoenix, Arizona. We also offer hosting services, which include hardware, infrastructure, ongoing maintenance and back-up services, to our customers with employees exclusively in Canada at two data centers owned and operated by Cyxtera (formerly known as CenturyLink), one near Toronto, Canada and one near Vancouver, Canada.
These hosting services, which are provided as part of our cloud offering, must be able to be reliably operated on a 24 hours per day, seven days per week basis without interruption or data loss. The success of the cloud offering depends on our ability to protect the infrastructure, equipment and customer data files against damage from:
Human error;
Natural disasters;
Power loss or telecommunication failures;
Sabotage or other intentional acts of vandalism; and
Unforeseen interruption or damages experienced in moving hardware to a new location.
We perform a daily backup of our customer data which is stored offsite of the data centers. In addition, QTS has implemented various activities comprising QualityTech’s Business Continuity Planning & Disaster Recovery Program which includes risk assessment and business impact analysis, redundancy and crisis and emergency response procedures.  Cyxtera also has a Business Continuity Program which handles business continuity planning, incident management and site emergency action planning.  However, the occurrence of one of the above listed events or other unanticipated problems at any of the data centers could:
Result in interruptions in the services we provide to our customers, during which time our customers may be unable to retrieve their data;
Require us to spend substantial amounts of money replacing existing equipment and/or purchasing services from an alternative data center;
Cause existing customers to cancel their contracts;
Cause our customers to seek damages for losses incurred; or
Make it more difficult for us to attract new customers.
We face risks associated with security breaches or cyber-attacks.
We face risks associated with security breaches or cyber-attacks of our computer systems and those of our third-party representatives, vendors and service providers. Although we have implemented security procedures and controls to address these threats, our systems and our software products may still be vulnerable to breaches, data theft, computer viruses, programming errors, attacks by third parties, or similar disruptive problems.
If our systems, or the hosting systems at our third party owned data centers, were breached or attacked, the proprietary and confidential information of our company and our customers could be disclosed, and we may be required to incur substantial costs and liabilities, including the following:
Expenses to rectify the consequences of the security breach or cyber-attack;
Liability for stolen assets or information;
Costs of repairing damage to our systems;
Lost revenue and income resulting from any system downtime caused by such breach or attack;
Loss of competitive advantage if our proprietary information is obtained by competitors as a result of such breach or attack;
Increased costs of cyber security protection;
Costs of incentives we may be required to offer to our customers or business partners to retain their business; and

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Damage to our reputation.
As a result, any compromise of security of our systems or cyber-attack could have a material adverse effect on our business, reputation, financial condition, and operating results.
Rapid technological changes and the introduction of new products and enhancements by new or existing competitors could undermine our current market position.
The market for our products is characterized by rapid technological advancements, changes in customer requirements, frequent new product introductions and enhancements and changing industry standards. The life cycles of our products are difficult to estimate. Rapid technological changes and the introduction of new products and enhancements by new or existing competitors could undermine our current market position. Our growth and future success will depend, in part, upon our ability to:
Enhance our current products and introduce new products in order to keep pace with products offered by our competitors;
Adapt to technological advancements and changing industry standards; and
Expand the functionality of our products to address the increasingly sophisticated requirements of our customers.
We may not have sufficient resources to make the necessary investments and we may experience difficulties that could delay or prevent the successful development, introduction or marketing of new products or enhancements. In addition, our products or enhancements may not meet the increasingly sophisticated customer requirements of the marketplace or achieve market acceptance at the rate we expect, or at all. Any failure by us to anticipate or respond adequately to technological advancements, customer requirements and changing industry standards, or any significant delays in the development, introduction or availability of new products or enhancements, could undermine our current market position.
Our business may be adversely impacted if the ACA is repealed in its entirety or certain aspects of the ACA are repealed or changed as a result of recent political changes.
The ACA remains subject to legislative efforts to repeal, modify or delay the implementation of the law. The recent Presidential and Congressional elections may result in additional or successful efforts to repeal, modify or delay implementation of all or certain aspects of the ACA. Generally, if the ACA is repealed or modified in whole or in part, or if implementation of certain aspects of the ACA is delayed, such repeal, modification or delay could adversely impact our existing and future business and operating results. For example, any such repeal, modification or delay could negatively impact the revenue we currently generate from our UltiPro ACA Toolkit or our UltiPro ACA Employer Services. While we expect continued challenges to the ACA, at this time we are unable to more precisely predict the full impact of any repeal, modification or delay in the implementation of the ACA.
Our acquisitions of other companies, products, or technologies may result in operating difficulties, dilution, and other harmful consequences that may adversely impact our business and results of operations.
As part of our overall business strategy, from time to time, we acquire complementary businesses, products and technologies. These transactions could be material to our financial condition and results of operations. We expect to continue to evaluate, and potentially enter into, acquisitions and a wide array of strategic transactions in the future.
We may not realize the anticipated benefits of our acquisitions to the extent that we anticipate, or at all, because acquisitions involve many risks, including:
difficulties integrating the acquired operations, personnel, technologies, products or infrastructure;
diversion of management's attention or other resources from other critical business operations and strategic priorities;
unexpected difficulties encountered when we enter new markets in which we have little or no experience, or where competitors may have stronger market positions;
inability to maintain relationships with customers and partners of the acquired business;
the difficulty of incorporating acquired technology and rights into our products and services;
potential unknown liabilities associated with an acquired business;
unanticipated expenses related to integrating acquired technology with our existing technology;
the impact on our results of operations due to depreciation and amortization related to acquired intangible assets, fixed assets and deferred compensation;
the tax effects of any such acquisitions;
potential litigation, such as claims by third parties related to intellectual property of the businesses we acquire;

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potential write-offs of our investments in acquired businesses;
the need to implement controls, procedures and policies appropriate for a public company at companies that prior to the acquisition lacked such controls, procedures and policies; and
challenges caused by distance, language and cultural differences.
Our failure to address these risks or other problems encountered in connection with our past or future acquisitions and strategic transactions could cause us to fail to realize the anticipated benefits of such acquisitions or transactions, incur unanticipated liabilities, and harm our business generally.
We may issue additional equity securities to pay for future acquisitions or other strategic transactions, the issuance of which could be dilutive to our existing stockholders and affect the trading price of our securities. If any acquisition or other strategic transactions is not perceived as ultimately improving our financial condition and operating results, our stock price may decline. Further, if we fail to properly evaluate and execute acquisitions or other strategic transactions, our business and financial condition may be seriously harmed.
Adverse changes in general economic or political conditions could adversely affect our operating results.
As our business has grown, we have become increasingly subject to the risks arising from adverse changes in domestic and global economic and political conditions.  If the state of the economy and the rate of employment deteriorate in the future, many customers may delay or reduce technology purchases.  This could result in reductions in sales of our products, longer sales cycles, slower adoption of new technologies, increased price competition, customers purchasing fewer services or Optional Capabilities than they have in the past, customers requesting longer payment terms, customers failing to pay amounts due and slower collections of accounts receivable.  In addition, increased unemployment could result in significant decreases in our recurring revenues from our existing customer base as we price our ongoing recurring revenues on a PEPM basis, subject, in many cases, to minimum employee sizes per customer. Any of these events would likely harm our business, results of operations, financial condition and cash flows from operations.
Defects and errors in our software could affect market acceptance of our products.
Software products such as those offered by us may contain undetected errors or failures when first introduced or as new versions are released. Testing of our products is particularly challenging because it is difficult to simulate the wide variety of computing environments in which our customers may use these products. Despite extensive testing, from time to time we have discovered defects or errors in our products. Defects and errors may:
Cause delays in product introductions and shipments;
Result in increased costs and diversion of development resources;
Require design modifications; or
Decrease market acceptance of, or customer satisfaction with, our products.
Despite testing by us and by current and potential customers, errors may be found after commencement of commercial shipments, which may result in loss of or delay in market acceptance which could have a material adverse impact upon our business, operating results and financial condition.
If our direct sales force is not successful, we may be unable to achieve significant revenue growth in the future.
We sell our products and services primarily through our direct sales force.  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. If our direct sales force does not perform as expected, our revenues could suffer.
Our current and future competitors include companies with greater financial, technical and marketing resources than we have and if we are unable to compete successfully with other businesses in our industry or with in-house systems developed by potential customers, our profitability will be adversely affected.
Our future success will depend significantly upon our ability to increase our share of our target market, to maintain and increase our recurring revenues from new and existing customers and to sell additional products, product enhancements, maintenance and support services and training and consulting services to existing and new customers. The HCM market is intensely competitive. Our competitors include:
Large service bureaus, primarily ADP and, to a lesser extent, Ceridian;
A number of companies, such as Oracle, Lawson, and Workday that offer HCM software products for use on mainframes, client/server environments and/or Web servers; and, in the UltiPro mid-market and strategic markets,

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payroll service providers such as ADP, Paychex, Ceridian, Paycom and Paylocity that service companies on the smaller end of the mid-market; and
The internal HR/payroll departments of potential customers which use custom-written software.
Our competitors may develop products that are superior to our products or achieve greater market acceptance. Many of our competitors or potential competitors have significantly greater financial, technical and marketing resources than we do. As a result, they may be able to respond more quickly to new or emerging technologies and to changes in customer requirements, or to devote greater resources to the development, promotion and sale of their products than we can. We believe that existing competitors and new market entrants will attempt to develop in-house systems that will compete with our products. We may be unable to compete successfully against current or future competitors. In addition, current and potential competitors have established or may establish cooperative relationships among themselves or with third parties to increase the ability of their products to address the needs of our prospective customers. Accordingly, it is possible that new competitors or alliances among competitors may emerge and rapidly acquire significant market share.
The loss of the services of one or more of our key employees could negatively affect our ability to implement our business strategy.
Our success depends to a significant extent upon a limited number of members of senior executive management and other key employees, including Scott Scherr, our Chairman of the Board of Directors, President and Chief Executive Officer. We do not have employment contracts with any of our key personnel. The loss of the services of one or more of our key employees could have a material adverse effect upon us. In addition, uncertainty created by turnover of our key employees could cause further turnover of our employees.
If we are not able to successfully recruit personnel, our revenues could be negatively affected.
Our ability to achieve significant revenue growth in the future will also depend on our success in recruiting, training and retaining sufficient sales, marketing, professional services, product development and other personnel.
The potential growth of our business and expansion of our customer base may place a significant strain on our management and operations, and we may be unable to manage that growth and expansion successfully.
We expect to increase research and development, professional services, sales and marketing and administrative operations as and when appropriate to accommodate our growth plans. Accordingly, our future operating results will depend on the ability of our management and other key employees to continue to implement and improve our systems for operations, financial control and information management and to recruit, train, manage and retain our employee base. We cannot be certain that we will be able to manage any future growth successfully.
Our business relies heavily on the products of Microsoft, which may not always be compatible with our products, and we may be required to spend significant capital if businesses adopt alternative technologies that are incompatible with our products.
Our software products are designed primarily to operate with Microsoft technologies and our strategy requires that our products and technology be compatible with new developments in Microsoft technology. Although we believe that Microsoft technologies are currently widely utilized by businesses of all sizes, we cannot be certain that businesses will continue to adopt such technologies as anticipated, will migrate from older Microsoft technologies to newer Microsoft technologies or will not adopt alternative technologies that are incompatible with our products. As a result, we may be required to develop new products or improve our existing products to be compatible with different technologies that may be used by our customers. We cannot be certain we will be able to adapt our product to any technologies other than Microsoft’s.
If our third-party software is not adequately maintained or updated or independent third party's products that we market and distribute as part of the UltiPro solution are no longer available to us, our sales could be materially adversely affected.
Certain products utilize software of third-party software developers or products from third parties from whom we have either purchased a license or the underlying source code of such software, entered into a service agreement with the vendor or have entered into a strategic alliance that gives us the right to market and distribute such product. Although we believe that there are alternatives for these products, any significant interruption in the availability of such third-party software or products could have a material adverse impact on our sales unless and until we can replace the functionality provided by these products. Additionally, we are, to a certain extent, dependent upon such third parties’ abilities to enhance their current products, to develop new products on a timely and cost-effective basis and to respond to emerging industry standards and other technological changes. We may be unable to replace the functionality provided by the third-party software or products currently

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offered in conjunction with our products in the event that such software or products become obsolete or incompatible with future versions of our products or are otherwise not adequately maintained, updated or available.
If we are unable to release annual or periodic updates on a timely basis to reflect changes in tax laws and regulations or other regulatory provisions applicable to our products, the market acceptance of our products may be adversely affected and our revenues could decline.
Our products are affected by changes in tax laws and regulations and generally must be updated annually or periodically to maintain their accuracy and competitiveness. We cannot be certain that we will be able to release these annual or periodic updates on a timely basis in the future. Failure to do so could have a material adverse effect on market acceptance of our products. In addition, significant changes in tax laws and regulations or other regulatory provisions applicable to our products could require us to make a significant investment in product modifications, which could result in significant unexpected costs to us.
If we are unable to protect our proprietary rights against unauthorized third-party copying or use, our revenues or our methods of doing business could be negatively impacted.
Our success is dependent, in part, on our ability to protect our proprietary rights. We rely on a combination of copyright, trademark and trade secret laws, as well as confidentiality agreements and licensing arrangements, to establish and protect our proprietary rights. We do not have any patents or patent applications pending, and existing copyright, trademark and trade secret laws afford only limited protection. As a result, we cannot be certain that we will be able to protect our proprietary rights against unauthorized third-party copying or use. Despite our efforts to protect our proprietary rights, unauthorized parties may attempt to copy or reverse engineer aspects of our products or to obtain and use information that we regard as proprietary. In addition, others may develop products that perform comparably to our proprietary products. Policing the unauthorized use of our products is difficult.
Litigation may be necessary in the future to enforce our intellectual property rights, to protect our trademarks, copyrights or trade secrets or to determine the validity and scope of the proprietary rights of others; such litigation may be expensive and divert the attention of management.
Litigation may be necessary in the future to enforce our intellectual property rights, to protect our trademarks, copyrights or trade secrets or to determine the validity and scope of the proprietary rights of others. Any litigation could result in substantial costs and diversion of resources and management attention.
As is common in the software industry, from time to time we may become aware of third-party claims of infringement by our operations or products of third-party proprietary rights. While we are not currently aware of any such material claim, our software products may increasingly be subject to such claims as the number of products and competitors in our industry grows, as the functionality of products overlaps and as the issuance of software patents becomes increasingly common. Any such claims, with or without merit, can be time consuming and expensive to defend, cause product shipment delays or require us to enter into royalty or licensing agreements. Such royalty or licensing agreements, if required, may not be available on terms acceptable to us, or at all.
Privacy concerns could result in regulatory changes that may harm our business.
Personal privacy is a significant issue in the United States and in many other countries where our customers operate.  The United States and many other countries have imposed restrictions and requirements on the use of personal information by those collecting such information.  Changes to law or regulations affecting privacy, if applicable to our business or product, could impose additional costs and potential liability on us and could limit our use and disclosure of such information.  If we were required to change our business activities or revise or eliminate services, our business could be harmed.
The sale and support of software products and the performance of related services by us entail the risk of product or service liability claims, which could significantly affect our financial results.
Customers use our products in connection with the preparation and filing of tax returns and other regulatory reports. If any of our products contain errors that produce inaccurate results upon which users rely, or cause users to misfile or fail to file required information, we could be subject to liability claims from users. Our cloud and maintenance renewal agreements with our customers typically contain provisions intended to limit our exposure to such claims, but such provisions may not be effective in limiting our exposure. Contractual limitations we use may not be enforceable and may not provide us with adequate protection against product liability claims in certain jurisdictions. A successful claim for product or service liability brought against us could result in substantial cost to us and divert management’s attention from our operations.

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We may be adversely affected by substantial quarterly fluctuations in our revenues and operating results.
Our quarterly revenues and operating results have varied significantly in the past and are likely to vary substantially from quarter to quarter in the future. Our quarterly operating results may fluctuate as a result of a number of factors, including:
Increased expenses from one quarter to another (especially as they relate to product development and sales and marketing);
Spending patterns of our customers;
Timing of our product releases;
Increased competition;
A drop in the near-term demand for our products, particularly in relation to professional services; and
Announcements of new products by Ultimate or by our competitors.
We establish our expenditure levels based upon our expectations as to future revenues, which are comprised primarily of recurring revenues and services revenues.   If revenue levels are below expectations, particularly services revenues which are more subject to variations between periods than recurring revenues, expenses can be disproportionately high in a particular period. For example, while sales production could be at our level of expectations, depending on the spending patterns of our customers including the timing in which they begin the implementation of UltiPro and the extent to which they use Ultimate’s resources, the immediate reported total revenues could be lower than expected.
Our operating results for previous fiscal quarters are not necessarily indicative of our operating results for the full fiscal years or for any future periods. We believe that, due to the underlying factors for quarterly fluctuations, quarter-to-quarter comparisons of our operations are not necessarily meaningful and that such comparisons should not be relied upon as indications of future performance.
Our stock price has experienced high volatility, may continue to be volatile and may decline.
The trading price of our Common Stock has fluctuated widely in the past and may do so in the future, as a result of a number of factors, many of which are outside our control, such as:
The volatility inherent in stock prices within the sector in which we conduct business;
The volume of trading in our Common Stock, including sales upon exercise of outstanding stock options and upon the vesting of restricted stock and restricted stock units;
Failure to achieve earnings expectations;
Changes in our earnings estimates by analysts;
Variations in our actual and anticipated operating results, including, but not limited to, prospective financial guidance provided by Ultimate to our investors and research analysts; and
Our ability to complete the Merger, and realize the anticipated benefits from the Merger; and
The diversion of management and employee time, the use of resources, and the incurrence of significant costs in seeking to complete the Merger;

Stock markets have experienced extreme price and volume fluctuations that have affected the market prices of many technology and computer software companies, particularly Internet-related companies. Such fluctuations have often been unrelated or disproportionate to the operating performance of these companies. These broad market fluctuations could adversely affect the market price of our Common Stock.
Further, securities class action litigation has often been brought against companies that experience periods of volatility in the market prices of their securities. Securities class action litigation could result in substantial costs and a diversion of our management’s attention and resources.
Anti-takeover provisions in our certificate of incorporation and by-laws and under our Amended and Restated Rights Agreement and Delaware law could substantially increase the cost to acquire us or prevent or delay a change in control and, as a result, negatively impact our stockholders and the price of our Common Stock.
We have taken a number of actions that could have the effect of discouraging a takeover attempt. For example, we have adopted an Amended and Restated Rights Agreement that would cause substantial dilution to a stockholder, and substantially increase the cost paid by a stockholder, who attempts to acquire us on terms not approved by our Board of Directors. This rights plan could prevent us from being acquired.
Our Board of Directors is divided into three classes, each of whose members serve for a staggered three-year term. This board structure may prevent stockholders from changing the composition of our Board of Directors quickly.

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In addition, our certificate of incorporation grants our Board of Directors the authority to fix the rights, preferences and privileges of and issue up to 2,500,000 shares of preferred stock without stockholder approval. Although we have no present intention to issue shares of preferred stock, such an issuance could have the effect of making it more difficult and less attractive for a third-party to acquire a majority of our outstanding voting stock. Preferred stock may also have other rights, including economic rights senior to our Common Stock, which could have a material adverse effect on our stock price.
We are also subject to the anti-takeover provisions of Section 203 of Delaware General Corporation Law. This section provides that a corporation may not engage in any business combination with any interested stockholder (as defined in that section) during the three-year period following the time that a stockholder became an interested stockholder.  This provision could have the effect of delaying or preventing a change in control of our company.
The growth of the international operations of our business subjects us to additional risks associated with foreign operations.
International operations are subject to risks associated with operating outside of the United States.  During the fourth fiscal quarter of 2006, we began operating in Canada (through the formation of a wholly-owned Canadian subsidiary).  During 2018, we continued to grow our operations in Canada and Singapore, and began operating in Europe through the acquisition of PeopleDoc SAS.  The financial impact of our international operations to our overall business has been insignificant to date.  However, over time, our international operations may grow and increase their significance to our business.  Sales to international customers subject us to a number of risks, including foreign currency fluctuations, unexpected changes in regulatory requirements for software, international economic and political instability, compliance with multiple, conflicting, and changing governmental laws and regulations, difficulty in staffing and managing foreign operations, international tax laws, potentially weaker protection for our intellectual property than in the United States, and difficulties in enforcing such rights abroad.  If sales to any of our customers outside of the United States are delayed or canceled because of any of the above factors, our revenue may be negatively impacted.
Our international operations also increase our exposure to international laws and regulations. If we are unable to comply with foreign laws and regulations, which are often complex and subject to variation and unexpected changes, we could incur unexpected costs and potential litigation.
If our goodwill or acquired intangible assets become impaired, we may be required to record a significant charge to earnings.
Under U.S. generally accepted accounting principles, we review our acquired intangible assets for impairment when events or changes in circumstances indicate that the carrying value may not be recoverable. Goodwill is required to be tested for impairment at least annually.  Factors that may be considered in circumstances indicating that the carrying value of our goodwill or acquired intangible assets may not be recoverable include a reduction in our market capitalization (as a result of a decline in our stock price) to a level below our consolidated stockholders’ equity as of the applicable balance sheet date, declining future cash flows, and slower growth rates in our industry.  We may be required to record a significant charge to earnings in our consolidated financial statements during the period in which any impairment of our goodwill or acquired intangible assets is determined, resulting in a negative impact on our results of operations.
Changes in, or interpretations of, accounting principles could result in unfavorable accounting changes.
We prepare our consolidated financial statements in conformity with U.S. generally accepted accounting principles and accompanying accounting pronouncements, implementation guidelines, and interpretations.  Changes in these rules or their interpretation could significantly change our reported results and may even retroactively affect previously reported transactions.  Our accounting principles that recently have been or may be affected by changes in accounting principles include, but are not limited to:  recurring revenue recognition and accounting for income taxes.
Changes in, or interpretations of, tax rules and regulations may adversely affect our effective tax rates.
Unanticipated changes in our tax rates could affect our future results of operations.  Our future effective tax rates could be unfavorably affected by changes in tax laws or the interpretation of tax laws, or by changes in the valuation of our deferred tax assets and liabilities.  In addition, we are subject to the examination of our income tax returns by the Internal Revenue Service and other domestic and foreign tax authorities.  We regularly assess the likelihood of outcomes resulting from these examinations to determine the adequacy of our provision for income taxes.  There can be no assurance that these potential examinations will not have an adverse effect on our operating results and financial position.


24


None.
Our corporate headquarters, which includes executive offices, operations and product development facilities, is located in Weston, Florida, and consists of approximately 345,000 square feet of leased space in multiple buildings, and one owned facility consisting of approximately 5,000 square feet. In addition, we and/or our wholly owned foreign subsidiaries lease office space in various locations throughout North America, Europe and Asia totaling approximately 360,000 square feet. We operate data centers in North America and Europe pursuant to various co-location license arrangements.
Currently, we also lease or license satellite offices for certain field personnel in various locations throughout North America and, to a much lesser extent, internationally.  
We believe that our existing facilities are suitable and adequate for our current operations for the next 12 months although we expect to expand our facilities capacity at our corporate headquarters and in certain field locations during fiscal 2019 to support our continued growth. We further believe that suitable space will be available as needed to accommodate any expansion of our operations on commercially reasonable terms.
From time to time, we are involved in litigation relating to claims arising out of our operations in the normal course of business. We are not currently a party to any legal proceedings the adverse outcome of which, individually or in the aggregate, could reasonably be expected to have a material adverse effect on our operating results or financial condition.
Not applicable.
PART II
Market Information.  Ultimate's Common Stock is traded on the NASDAQ Global Select Market (“NASDAQ”) under the symbol “ULTI." As of February 19, 2019, we had approximately 66 holders of record, representing approximately 4,689 stockholder accounts.

25


Performance Graph.  The following graph compares the cumulative total stockholder returns on Ultimate’s Common Stock for the five year period covering December 31, 2013-December 31, 2018, on an annual basis, with the cumulative total return of the NASDAQ Composite Index and the RDG Software Composite Index for the same period.
capturea04.jpg
Purchases of Equity Securities by the Issuer. On October 30, 2000, Ultimate announced that our Board of Directors authorized the repurchase of up to 1,000,000 shares of our outstanding Common Stock (the “Stock Repurchase Plan”).
On February 6, 2007, Ultimate’s Board of Directors extended the Stock Repurchase Plan by authorizing the repurchase of up to 1,000,000 additional shares of our issued and outstanding Common Stock.
On February 5, 2008, Ultimate’s Board of Directors extended the Stock Repurchase Plan further by authorizing the repurchase of up to 1,000,000 additional shares of our Common Stock.
On October 26, 2009, Ultimate’s Board of Directors extended the Stock Repurchase Plan further by authorizing the repurchase of up to 1,000,000 additional shares of our Common Stock.
On October 24, 2011, Ultimate’s Board of Directors extended the Stock Repurchase Plan further by authorizing the repurchase of up to 1,000,000 additional shares of our Common Stock.
On April 25, 2016, Ultimate's Board of Directors extended our Stock Repurchase Plan further by authorizing the repurchase of up to 1,000,000 additional shares of our Common Stock.
As of December 31, 2018, Ultimate had purchased 4,657,995 shares of our Common Stock under the Stock Repurchase Plan, with 1,342,005 shares available for repurchase in the future.  

26


The number of shares of Common Stock repurchased by us during the three months ended December 31, 2018 is as indicated below:
Period
 
Total Number of Shares Purchased (1)
 
Average Price Paid per Share
 
Total Cumulative Number of Shares Purchased as Part of Publicly Announced Plans or Programs
 
Maximum Number of Shares That May Yet Be Purchased Under the Plans or Programs
October 1 – 31, 2018
 
14 (1)
 
$
295.69

 
4,657,995

 
1,342,005

November 1 – 30, 2018
 
34,864 (1)
 
$
258.39

 
4,657,995

 
1,342,005

December 1 – 31, 2018
 
360 (1)
 
$
238.59

 
4,657,995

 
1,342,005

(1) Represents shares of Common Stock that were acquired by us at the fair market value of the Common Stock as of the period stated, in connection with the satisfaction of our employees' tax withholding liability resulting from the vesting of restricted stock holdings.

27


The following selected consolidated financial data is qualified by reference to and should be read in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and Ultimate’s Consolidated Financial Statements and Notes thereto included elsewhere in this Form 10-K. The consolidated statements of income data presented below for each of the years in the three-year period ended December 31, 2018 and the consolidated balance sheet data as of December 31, 2018 and 2017 have been derived from our Consolidated Financial Statements included elsewhere in this Form 10-K. The years ended December 31, 2016, 2015, and 2014 were revised in connection with an immaterial correction of prior period financial statements. See Note 18 in our Notes to Consolidated Financial Statements for further discussion.

28


 
Years Ended December 31,
 
2018
 
2017
 
2016
 
2015
 
2014
Consolidated Statements of Income: (in thousands, except per share data)
Revenues:
 
 
 
 
 
 
 
 
 
Recurring
$
997,066

 
$
802,300

 
$
654,199

 
$
516,400

 
$
419,771

Services
143,478

 
138,429

 
127,092

 
101,681

 
86,165

Total revenues
1,140,544

 
940,729

 
781,291

 
618,081

 
505,936

Cost of revenues:
 

 


 


 


 


Recurring
273,165

 
210,560

 
172,676

 
138,587

 
117,700

Services
158,569

 
143,140

 
127,433

 
99,948

 
85,939

Total cost of revenues
431,734

 
353,700

 
300,109

 
238,535

 
203,639

Gross profit
708,810

 
587,029

 
481,182

 
379,546

 
302,297

Operating expenses:
 

 


 


 


 


Sales and marketing
285,293

 
269,781

 
224,416

 
169,664

 
117,033

Research and development
203,729

 
150,583

 
120,650

 
93,671

 
83,542

General and administrative
139,192

 
122,119

 
94,432

 
72,893

 
47,379

Total operating expenses
628,214

 
542,483

 
439,498

 
336,228

 
247,954

Operating income
80,596

 
44,546

 
41,684

 
43,318

 
54,343

Other (expense) income:
 

 
 

 
 

 
 

 
 

Interest expense and other, net
(693
)
 
(813
)
 
(717
)
 
(491
)
 
(353
)
Other income, net
3,458

 
397

 
451

 
256

 
339

Total other income (expense), net
2,765

 
(416
)
 
(266
)
 
(235
)
 
(14
)
Income before income taxes
83,361

 
44,130

 
41,418

 
43,083

 
54,329

Provision for income taxes
(18,221
)
 
(30,075
)
 
(12,178
)
 
(28,825
)
 
(13,640
)
Net income
65,140

 
14,055

 
29,240

 
14,258

 
40,689

 
 
 
 
 
 
 
 
 
 
Net income per share: (1)
 

 


 


 


 


Basic
$
2.11

 
$
0.47

 
$
1.01

 
$
0.50

 
$
1.44

Diluted
$
2.06

 
$
0.46

 
$
0.96

 
$
0.48

 
$
1.39

 
 
 
 
 
 
 
 
 
 
Weighted average shares outstanding: (1)
 

 
 

 
 

 
 

 
 

Basic
30,854

 
29,791

 
28,976

 
28,634

 
28,293

Diluted
31,578

 
30,799

 
30,414

 
29,721

 
29,343

 
 
 
 
 
 
 
 
 
 
Balance Sheet Data: (in thousands)
As of December 31,
 
2018
 
2017
 
2016
 
2015
 
2014
Cash and cash equivalents
$
151,247

 
$
155,685

 
$
73,773

 
$
109,325

 
$
108,298

Corporate investments in marketable securities
10,741

 
9,434

 
24,088

 
20,058

 
10,156

Total assets
1,920,717

 
1,377,211

 
1,134,688

 
1,448,689

 
1,181,859

Deferred revenue
239,949

 
198,861

 
173,976

 
145,727

 
109,705

Long-term borrowings, including capital lease obligations
6,239

 
8,727

 
3,985

 
3,665

 
3,759

Stockholders’ equity
$
844,978

 
$
518,025

 
$
414,215

 
$
317,186

 
$
263,310

________________________________
(1)
See Note 11 of the Notes to the Consolidated Financial Statements for information regarding the computation of net earnings per share.


29


Our Management’s Discussion and Analysis of Financial Condition and Results of Operations provides information we believe is relevant to an assessment and understanding of our results of operations and financial condition.  This discussion should be read in conjunction with our Consolidated Financial Statements and Notes that are included in this Form 10-K.  Also, the discussion of Critical Accounting Policies in this section is an integral part of the analysis of our results of operations and financial condition.
Business Overview
With offices in the United States, Canada, France, Germany, England, and Singapore, Ultimate Software is a leading provider of cloud-based human capital management solutions—often referred to as human capital management ("HCM")—and employee experience solutions. Ultimate's UltiPro product suite is a comprehensive, engaging solution that has human resources ("HR") and payroll at its core and includes benefits management, talent acquisition, talent management, time management, and global people management functionality available in 14 languages with 61 country-specific localizations. Ultimate also offers a-la-carte employee experience solutions, such as HR Service Delivery and "Perception," an employee-sentiment analysis solution.
Ultimate's solutions are delivered via software-as-a-service ("SaaS"), now more commonly known as cloud computing, to organizations with employees in the United States, Canada, Europe, Asia Pacific, and other global locations. At the close of 2018, we had more than 5,600 organizations as customers and more than 48 million people records in our cloud environment. We attained our leadership position, we believe, through our exclusive focus on solutions that help companies manage their employees in an engaging way. Key factors in our success have been our people-centric product design, cloud technology, and strong customer relationships nurtured by our services team and throughout the Ultimate organization.
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 talent acquisition and onboarding, HR service delivery and management, 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 and functions on mobile devices such as the iPhone, iPad, and Android 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 and develop the talent in their workforces more strategically. UltiPro provides our customers intelligent tools and insights for engaging workforces and understanding organizational dynamics, analyzing trends for better decision making, identifying high-performing talent, predicting who future high-performers and what retention risks will be with a high degree of accuracy, finding critical information quickly and performing routine business activities efficiently.
Our cloud offering of UltiPro provides web-based and mobile 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

30


(performance management, talent predictors, and succession management); (iii) learning management; (iv) employee engagement surveys; (v) compensation management; (vi) benefits enrollment; (vii) time and scheduling management; (viii) payment services; (ix) wage attachments; (x) HR service delivery; 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 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 year ended December 31, 2018, our (i) recurring revenues grew by 24.3%, compared with the same period in 2017, and (ii) Non-GAAP Operating Income was $234.1 million, or 20.5% of total revenues, as compared with $194.1 million, or 20.6% of total revenues, for the same period in 2017. For the year ended December 31, 2017, our (i) recurring revenues grew by 22.6%, compared with the same period in 2016, and (ii) Non-GAAP Operating Income was $194.1 million or 20.6% of total revenues, as compared with $157.6 million, or 20.2% of total revenues, for the same period in 2016. As of December 31, 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”).

Merger Agreement

On February 3, 2019, Ultimate entered into the Merger Agreement with Parent and Merger Sub. Pursuant to the Merger Agreement, Ultimate would be acquired by an investor group led by HF, a leading private equity investment firm, in an all-cash transaction for $331.50 per share in cash (representing an aggregate value of approximately $11 billion), after which Ultimate would operate as a privately held company. See Part I, Item 1A and “Risk Factors” for additional information.

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

31


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 Consolidated Financial Statements.

Critical Accounting Policies & 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, liabilities, revenues, costs and expenses and related disclosures. Such estimates include, but are not limited to, revenue recognition, income taxes, and the valuation of deferred tax assets, long-lived assets and acquired intangible assets through business combinations. On an ongoing basis, we evaluate our estimates and assumptions. Our actual results may differ from those estimates under different assumptions or conditions.
We believe that of our significant accounting policies, which are described in Note 3, "Summary of Significant Accounting Policies and Recent Accounting Pronouncements," to our consolidated financial statements, the following accounting policies involve a greater degree of judgment and complexity. Accordingly, these are the policies we believe are the most critical to aid in fully understanding and evaluating our consolidated financial condition and results of operations.
Revenue Recognition
Effective January 1, 2018, we recognize revenues in accordance with Accounting Standards Update ("ASU") 2014-09, “Revenue from Contracts with Customers” (“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:
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 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,

32


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 also 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.

Capitalized Internal-Use Software Costs
We follow the guidance of Accounting Standards Codification ("ASC") Topic 350-40, "Intangibles Goodwill and Other-Internal Use Software" (“ASC 350”), in accounting for costs related to software developed for internal use. ASC 350 requires companies to capitalize qualifying computer software costs, which are incurred during the application development stage. Costs capitalized during the application development stage include external direct costs of materials and services consumed in developing or obtaining internal-use software and payroll and payroll-related costs for employees who are directly associated with, and who devote time to, the internal-use computer software. In addition to capitalizing costs for software (which are used by us in our general operations, for internal purposes), we also capitalize costs under ASC Topic 350-40 for certain software development projects related to our suite of products sold to our customers exclusively on a subscription basis under our software-as-a-service ("SaaS") offering of UltiPro.
Costs related to preliminary project activities and post implementation activities are expensed as incurred. Internal-use software is amortized on a straight-line basis over its estimated useful life. We evaluate the useful lives of these assets on an annual basis and test for impairment whenever events or changes in circumstances occur that could impact the recoverability of these assets. To the extent there is amortization of capitalized costs associated with development projects for UltiPro sold to our customers on a SaaS basis, the related amortization is included with cost of recurring revenues upon the commencement of that amortization period.
Goodwill and Intangible Assets
The purchase price of an acquired company is allocated between intangible assets and the net tangible assets of the acquired business with the residual of the purchase price recorded as goodwill. The determination of the value of the intangible assets acquired involves certain judgments and estimates. These judgments and estimates can include, but are not limited to, the cash flows that an asset is expected to generate in the future and the appropriate weighted average cost of capital.
At December 31, 2018, our goodwill totaled $219.9 million and our identifiable net intangible assets totaled $144.4 million. We assess the impairment of goodwill of our reporting unit annually, or more often if events or changes in circumstances indicate that the carrying value may not be recoverable.  Goodwill is tested for impairment at the reporting unit level by first performing a qualitative assessment to determine whether it is more likely than not that the fair value of the reporting unit is less than its carrying value.  If the reporting unit does not pass the qualitative assessment, then the reporting unit's carrying value is compared to its fair value.  We consider both market and discounted cash flow approaches to determine the fair value of the reporting unit.  Goodwill is considered impaired if the carrying value of the reporting unit exceeds its fair value.  The discounted cash flow approach uses expected future operating results.  Failure to achieve these expected results may cause a future impairment of goodwill at the reporting unit.  We conducted our annual impairment test of goodwill as of December 31, 2018, and 2017.  As a result of this test, we determined that no adjustment to the carrying value of goodwill for our reporting unit was required. 
We evaluate our amortizable intangible assets for impairment whenever events or changes in circumstances indicate that the carrying value of an asset may not be recoverable based on expected undiscounted cash flows attributable to that asset or group of assets. The amount of any impairment is measured as the difference between the carrying value and the fair value of the impaired asset. We also evaluate the estimated remaining useful lives of intangible assets and whether events or changes in circumstances warrant a revision to the remaining periods of amortization. Assumptions and estimates about future values and remaining useful lives of our intangible assets are complex and subjective. They can be affected by a variety of factors,

33


including external factors such as industry and economic trends and internal factors such as changes in our business strategy and our internal forecasts.

Results of Operations
The following table sets forth the consolidated statements of income data of Ultimate, as a percentage of total revenues, for the periods indicated. The year ended December 31, 2016 was revised in connection with an immaterial correction of prior period financial statements. See Note 18 of the Notes to Consolidated Financial Statements for further discussion.
 
For the Years Ended December 31,
 
2018
 
2017
 
2016
Revenues:
 
 
 
 
 
Recurring
87.4
 %
 
85.3
 %
 
83.7
 %
Services
12.6

 
14.7

 
16.3

Total revenues
100.0

 
100.0

 
100.0

Cost of revenues:
 

 
 

 
 

Recurring
24.0

 
22.4

 
22.1

Services
13.9

 
15.2

 
16.3

Total cost of revenues
37.9

 
37.6

 
38.4

Gross profit
62.1

 
62.4

 
61.6

Operating expenses:
 

 
 

 
 

Sales and marketing
25.0

 
28.7

 
28.7

Research and development
17.8

 
16.0

 
15.5

General and administrative
12.2

 
13.0

 
12.1

Total operating expenses
55.0

 
57.7

 
56.3

Operating income
7.1

 
4.7

 
5.3

Other income (expense):
 

 
 

 
 

Interest expense and other, net

 

 
(0.1
)
Total other expense, net
0.2

 

 
0.1

Total other income (expense), net
0.2

 

 

Income before income taxes
7.3

 
4.7

 
5.3

Provision for income taxes
(1.6
)
 
(3.2
)
 
(1.6
)
Net income
5.7
 %
 
1.5
 %
 
3.7
 %
The following table sets forth the non-cash stock-based compensation expense resulting from stock-based arrangements that is recorded in our consolidated statements of income for the periods indicated (in thousands):
 
For the Years Ended December 31,
 
2018
 
2017
Cost of recurring revenues
$
16,087

 
$
11,931

Cost of services revenues
9,472

 
7,909

Sales and marketing
71,641

 
75,428

Research and development
16,275

 
12,026

General and administrative
26,878

 
39,133

Total stock-based compensation expense
$
140,353

 
$
146,427


Comparison of Fiscal Years Ended December 31, 2018 and 2017

34


Revenues
Our revenues are derived from recurring revenues and services revenues.  See “Revenue Recognition” above for further discussion of Ultimate’s revenue sources and its method of accounting for each of them.
Total revenues increased 21.2% to $1,140.5 million for 2018 from $940.7 million for 2017.
Recurring revenues, primarily consisting of subscription revenues from cloud-based UltiPro, increased 24.3% to $997.1 million for 2018 from $802.3 million for 2017.  The increase in recurring revenues for 2018 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 December 31, 2017, including the UltiPro core product and, to a lesser extent, Optional Capabilities of UltiPro. Cloud subscription 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 customers was approximately 96% at the end of 2018 (calculated on a 12-month rolling basis) which compares to approximately 96% at the end of 2017. 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 3.6% to $143.5 million for 2018 from $138.4 million for 2017. The increase in services revenues for the year was primarily due 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 22.1% to $431.7 million for 2018, from $353.7 million for 2017.
Cost of recurring revenues increased 29.7% to $273.2 million for 2018 from $210.6 million for 2017.  The $62.6 million increase in the cost of recurring revenues for the year was 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 project to be sold in the future as a cloud product only (the "Development Project") which resulted from other product modules becoming available for their intended use.
For the year ended December 31, 2018, the increases in cloud costs were 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 increase in Customer Support costs for the year ended December 31, 2018 was primarily due to higher labor costs commensurate with the growth in the number of cloud customers serviced.
Cost of services revenues increased 10.8% to $158.6 million for 2018 from $143.1 million for 2017.  The $15.4 million increase in cost of services revenues was primarily due to an increase in the cost of implementation, including higher labor and related costs and, to a lesser extent, the increased use of third-party implementation partners.
Sales and Marketing
Sales and marketing expenses consist primarily of salaries and benefits, sales commissions, travel and promotional expenses, and facility and communication costs for direct sales offices, as well as advertising and marketing costs. Sales and marketing expenses increased 5.7% to $285.3 million for 2018 from $269.8 million for 2017.  The $15.5 million increase in sales and marketing during 2018 was primarily due to increased labor and related costs (including the impact of an increase in sales personnel) and, to a lesser extent, higher advertising and marketing expenses, partially offset by lower sales commissions resulting from the adoption of Topic 606 due to the longer amortization period under this new standard. Effective January 1, 2018, we adopted the requirements Topic 606 resulting in a change in the amortization period of deferred incremental

35


commission costs from 2 - 3 years under Topic 605, to 7 years under Topic 606. The 7 year amortization period is based on analyzing our customer contract term periods and our customer life, taking into consideration technological changes for our UltiPro product offering. Deferred incremental commission costs are amortized on a systemic basis, consistent with the pattern of transfer of the goods or services to which the asset relates.

Research and Development
Research and development expenses consist primarily of software development personnel costs. Research and development expenses increased 35.3% to $203.7 million in 2018 from $150.6 million in 2017.  The $53.1 million increase in research and development expenses during 2018 was principally due to higher labor and related costs associated with the ongoing development of UltiPro and Optional Capabilities, including the impact of increased personnel costs (predominantly from additional headcount), net of capitalized labor costs. For the years ended December 31, 2018 and 2017, we capitalized $54.0 million (including $3.5 million in non-cash stock-based compensation) and $52.6 million (including $4.0 million in non-cash stock-based compensation), respectively, of computer software development costs related to the Development Project. The capitalized costs for the Development Project were primarily from direct labor costs and, to a lesser extent, third party consulting fees for the years ended December 31, 2018 and 2017. For the years ended December 31, 2018 and 2017, there was $9.9 million and $4.4 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.
General and Administrative
General and administrative expenses consist primarily of salaries and benefits of executive, administrative and financial personnel, as well as facility costs, external professional fees and the provision for doubtful accounts. General and administrative expenses increased by 14.0% to $139.2 million for 2018 from $122.1 million for 2017.  The $17.1 million increase in general and administrative expenses during 2018 was primarily due to higher labor and related costs, including increased personnel to support Ultimate's growth in operations, increased professional fees and an increase in the provision for doubtful accounts.
Provision for Income Taxes
In 2018, based on pre-tax income, we had income tax expense of $18.2 million as compared with $30.1 million in 2017. The decrease in income tax expense of $11.9 million was attributable to the revaluation in the federal statutory tax rate from 35% to 21% effective January 1, 2018 due to the passing of the federal Tax Cuts and Jobs Act by the federal government on December 22, 2017 and a reduction in the Summary of Interpretation No. 48 ("FIN 48") reserve attributable to an IRS examination settled in 2018.
Comparison of Fiscal Years Ended December 31, 2017 and 2016
Revenues
Our revenues are derived from recurring revenues and services revenues.  See “Revenue Recognition” above for further discussion of Ultimate’s revenue sources and its method of accounting for each of them.
Total revenues increased 20.4% to $940.7 million for 2017 from $781.3 million for 2016.
Recurring revenues, primarily consisting of subscription revenues from cloud-based UltiPro, increased 22.6% to $802.3 million for 2017 from $654.2 million for 2016.  The increase in recurring revenues for 2017 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 December 31, 2016, including the UltiPro core product and, to a lesser extent, Optional Capabilities of UltiPro. Cloud subscription 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 customers was approximately 96% at the end of 2017 (calculated on a 12-month rolling basis) which compares to approximately 97% at the end of 2016. 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 8.9% to $138.4 million for 2017 from $127.1 million for 2016. The increase in services revenues for the year was primarily due to additional implementation revenues to support increased sales and, to a lesser extent, as a result of increased fixed fee implementations primarily in association with interfaces with UltiPro.

36


As previously discussed in our second quarter 2017 Form 10-Q, during 2017, we experienced an elongation in our Time-to-Live periods for our sales in our backlog (i.e., those which had not gone Live yet) for our enterprise sales, as well as our mid-market sales, which caused our expected 2017 revenues (both recurring and services) to be less than our original projections. The extension of the Time-to-Live periods does not change the overall value of recurring revenues or our fixed fee implementations (included with services revenues) from these customers and is essentially a timing issue. We do not believe that our Time-to-Live periods will elongate beyond our 2017 experience and have factored the revised Time-to-Live periods into our 2018 revenue expectations.
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 17.9% to $353.7 million for 2017, from $300.1 million for 2016.
Cost of recurring revenues increased 21.9% to $210.6 million for 2017 from $172.7 million for 2016.  The $37.9 million increase in the cost of recurring revenues for the year was 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 project to be sold in the future as a cloud product only (the "Development Project") which resulted from other product modules becoming available for their intended use during the last half of 2017.
For the year ended December 31, 2017, the increases in cloud costs were 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 increase in Customer Support costs for the year ended December 31, 2017 was 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 $143.1 million for 2017 from $127.4 million for 2016.  The $15.7 million increase in cost of services revenues was primarily due to an increase in the cost of implementation, including higher labor and related costs and the increased use of third-party implementation partners.
Sales and Marketing
Sales and marketing expenses consist primarily of salaries and benefits, sales commissions, travel and promotional expenses, and facility and communication costs for direct sales offices, as well as advertising and marketing costs. Sales and marketing expenses increased 20.2% to $269.8 million for 2017 from $224.4 million for 2016.  The $45.4 million increase in sales and marketing during 2017 was primarily due to increased labor and related costs (including the impact of an increase in sales personnel, primarily in our mid-market and strategic sales channels, and higher sales commissions) and higher advertising and marketing expenses, which included media advertising. Included in the increased labor and related costs for 2017 was a portion of certain non-cash, stock-based compensation expenses relating to the revisions and terminations of our change in control plans ("CIC Plans"). Prior to the adoption of Topic 606 on January 1, 2018, commissions on subscription-based cloud sales were are amortized over the initial contract term (typically 24 to 36 months) typically commencing on the Live date.
Research and Development
Research and development expenses consist primarily of software development personnel costs. Research and development expenses increased 24.8% to $150.6 million in 2017 from $120.7 million in 2016.  The $29.9 million increase in research and development expenses during 2017 was principally due to higher labor and related costs associated with the ongoing development of UltiPro and Optional Capabilities, including the impact of increased personnel costs (predominantly from additional headcount), net of capitalized labor costs. For the years ended December 31, 2017 and 2016, we capitalized $52.6 million (including $4.0 million in non-cash stock-based compensation) and $37.9 million (including $3.9 million in non-cash stock-based compensation), respectively, of computer software development costs related to the Development Project. The capitalized costs for the Development Project were primarily from direct labor costs and, to a lesser extent, third party consulting fees for the years ended December 31, 2017 and 2016. For the years ended December 31, 2017 and 2016, there was $4.4 million and $1.2 million, respectively, of amortization associated with certain product modules of the Development

37


Project which were ready for their intended use. The amortization of capitalized software is included in cost of recurring revenues.
General and Administrative
General and administrative expenses consist primarily of salaries and benefits of executive, administrative and financial personnel, as well as facility costs, external professional fees and the provision for doubtful accounts. General and administrative expenses increased by 29.3% to $122.1 million for 2017 from $94.4 million for 2016.  The $27.7 million increase in general and administrative expenses during 2017 was primarily due to higher labor and related costs, including increased personnel to support Ultimate's growth in operations, an increase in professional fees, an increase in facility costs to support the growth in headcount, and a portion of certain non-cash, stock-based compensation expenses for the revisions and terminations of our CIC Plans.
Provision for Income Taxes
In 2017, based on pre-tax income, we had income tax expense of $30.1 million as compared with $12.2 million in 2016. The increase in income tax expense of $17.9 million was attributable to the revaluation of the net deferred tax asset balance from the reduction in federal statutory tax rates per the enactment of the federal Tax Cut and Jobs Act (the "Tax Act"), passed in December 2017. The Tax Act made broad and complex changes to the U.S. tax code including but not limited to reducing the federal statutory tax rate from 35% to 21%, effective January 1, 2018. During the quarter ended December 31, 2017, we adjusted the statutory federal and state income tax rates to our net deferred tax assets. The remaining increase to income tax expense was due to an increase in non-deductible expenses, primarily stock-based compensation, and a resulting higher ratio of non-deductible expenses to pre-tax income.  Ultimate recorded $4.5 million and $4.0 million of research and development tax credit carryforwards during the years ended December 31, 2017 and December 31, 2016, respectively.
Quarterly Results of Operations
The following table sets forth certain unaudited quarterly results of operations for each of the quarters in the years ended December 31, 2018 and 2017. In management’s opinion, this unaudited information has been prepared on the same basis as the audited consolidated financial statements and includes all adjustments (consisting only of normal recurring adjustments) necessary for a fair presentation of the information for the quarters presented.
This information should be read in conjunction with Ultimate’s Consolidated Financial Statements and Notes thereto included elsewhere in this Form 10-K.
Our quarterly revenues and operating results have varied significantly in the past and are likely to vary substantially from quarter to quarter in the future. Our operating results may fluctuate as a result of a number of factors, including, but not limited to, increased expenses (especially as they relate to product development, sales and marketing and the use of third-party consultants), timing of product releases, increased competition, variations in the mix of revenues, announcements of new products by us or our competitors and capital spending patterns of our customers. We establish our expenditure levels based upon our expectations as to future revenues, and, if revenue levels are below expectations, expenses can be disproportionately high. A drop in near term demand for our 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 we will be able to achieve or maintain profitability on a quarterly basis. We believe that, due to the underlying factors for quarterly fluctuations, quarter-to-quarter comparisons of Ultimate’s operations are not necessarily meaningful and that such comparisons should not be relied upon as indications of future performance.

38


Quarters Ended
 
Dec 31,
2018
 
Sep 30,
2018
 
Jun 30,
2018
 
Mar 31,
2018
 
Dec 31,
2017
 
Sep 30,
2017
 
Jun 30,
2017
 
Mar 31,
2017
(In thousands, except per share data)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
(Unaudited)
Revenues:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Recurring
 
$
266,444

 
$
254,580

 
$
239,458

 
$
236,587

 
214,112

 
203,059

 
195,147

 
189,981

Services
 
38,359

 
33,247

 
31,704

 
40,168

 
37,319

 
33,054

 
29,545

 
38,510

Total revenues
 
304,803

 
287,827

 
271,162

 
276,755

 
251,431

 
236,113

 
224,692

 
228,491

Cost of revenues:
 
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

Recurring
 
72,434

 
71,243

 
66,623

 
62,865

 
55,394

 
52,558

 
52,539

 
50,069

Services
 
40,141

 
40,571

 
35,949

 
41,908

 
35,659

 
36,136

 
31,715

 
39,631

Total cost of revenues
 
112,575

 
111,814

 
102,572

 
104,773

 
91,053

 
88,694

 
84,254

 
89,700

Gross profit
 
192,228

 
176,013

 
168,590

 
171,982

 
160,378

 
147,419

 
140,438

 
138,791

Operating expenses:
 
 

 
 

 
 

 
 

 
 
 
 

 
 

 
 

Sales and marketing
 
75,812

 
72,077

 
66,207

 
71,197

 
68,339

 
65,066

 
67,015

 
69,360

Research and development
 
55,588

 
51,163

 
50,004

 
46,974

 
41,013

 
38,415

 
34,997

 
36,158

General and administrative
 
37,939

 
37,261

 
32,270

 
31,722

 
30,983

 
29,459

 
31,472

 
30,204

Total operating expenses
 
169,339

 
160,501

 
148,481

 
149,893

 
140,335

 
132,940

 
133,484

 
135,722

Operating income
 
22,889

 
15,512

 
20,109

 
22,089

 
20,043

 
14,479

 
6,954

 
3,069

Other income (expense):
 
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

Interest expense and other, net
 
(128
)
 
(268
)
 
(100
)
 
(197
)
 
(129
)
 
(239
)
 
(165
)
 
(280
)
Other income, net
 
922

 
1,353

 
794

 
385

 
34

 
57

 
81

 
226

Total other income (expense), net
 
794

 
1,085

 
694

 
188

 
(95
)
 
(182
)
 
(84
)
 
(54
)
Income before income taxes
 
23,683

 
16,597

 
20,803

 
22,277

 
19,948

 
14,297

 
6,870

 
3,015

(Provision) benefit for income taxes
 
(10,303
)
 
488

 
(7,123
)
 
(1,283
)
 
(22,005
)
 
(9,954
)
 
(2,341
)
 
4,225

Net income (loss)
 
$
13,380

 
$
17,085

 
$
13,680

 
$
20,994

 
$
(2,057
)
 
$
4,343

 
$
4,529

 
$
7,240

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Earnings (loss) per share:
 
 

 
 

 
 

 
 

 
 
 
 

 
 

 
 

  Basic
 
$
0.43

 
$
0.55

 
$
0.45

 
$
0.69

 
$
(0.07
)
 
$
0.15

 
$
0.15

 
$
0.25

  Diluted
 
$
0.42

 
$
0.54

 
$
0.44

 
$
0.67

 
$
(0.07
)
 
$
0.14

 
$
0.15

 
$
0.24

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Weighted average shares outstanding:
 
 

 
 

 
 

 
 

 
 
 
 

 
 

 
 

Basic
 
31,304

 
31,077

 
30,619

 
30,404

 
30,021

 
29,848

 
29,751

 
29,538

Diluted
 
31,976

 
31,775

 
31,113

 
31,105

 
30,021

 
30,770

 
30,623

 
30,497

Seasonality
We have experienced, and may experience in the future, seasonality in our business, and our business, operating results and financial condition may be affected by such trends in the future. Ultimate'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. Revenues have historically increased at higher rates in the fourth quarter of the year and at lower rates in the next succeeding quarter. We believe such seasonality is due to a number of factors, including our quota-based compensation arrangements, typical of those used in software companies, and year-end budgetary pressures on our customers. We believe that the seasonal trend that Ultimate has experienced in the past may continue in the foreseeable future.

39


Liquidity and Capital Resources
In recent years, we have funded operations primarily from cash flows generated from operations.
As of December 31, 2018, we had $162.0 million in cash, cash equivalents and short-term corporate investments in marketable securities, reflecting a net decrease of $3.1 million since December 31, 2017.  The total decrease in cash was primarily from $74.4 million of cash used for the acquisition of PeopleDoc, cash purchases of property and equipment (including principal payments on financed equipment) of $80.6 million primarily consisting of $50.5 million in capitalized labor costs (excluding non-cash stock-based compensation of $3.5M) and third party consulting fees, paid in cash, associated with the Development Project, and cash used to settle the employee tax withholding liability for vesting of restricted stock awards and restricted stock units of $64.8 million, partially offset by cash provided by operations of $223.9 million and proceeds from the issuances of Common Stock from employee and nonemployee director stock option exercises of $3.3 million.
Our operating cash inflows primarily consist of payments received from our UltiPro customers. Our operating cash outflows primarily consist of cash we invest in personnel and infrastructure to support the anticipated growth of our business, payments to vendors related to our operations, payments under arrangements with third party vendors who provide hosting infrastructure services in connection with UltiPro, related sales and marketing costs, other costs of operations, as well as systems development and programming costs. Net cash provided by operating activities increased $9.9 million during 2018 as compared with 2017. This increase was primarily due to an increase in operating income (after adjusting for the impact of non-cash expenses) of $51.1 million, partially offset by cash paid for working capital of $38.2 million.
Net cash used in investing activities was $209.9 million for 2018 as compared with net cash used in investing activities of $162.7 million for 2017.  The $50.3 million in cash paid from 2017 was primarily attributable to cash paid of $74.4 million for the acquisition of PeopleDoc, partially offset by a net change in funds received from our customers using the UltiPro payment services offering (“UltiPro Payment Services”) of $53.9 million and an increase in the maturities of marketable securities of $82.3 million (which includes the maturities for the period of $189.2 million of marketable securities originally purchased with funds held for customers in addition to our corporate funds).We invest our customer funds in available for sale securities along with our corporate funds in accordance with our internal investment strategies. The portfolio predominantly consists of investment grade securities with long-term ratings of AAA and AA+ and short-term ratings A-1/P-1. Customer funds not invested in available for sale securities, temporarily held by us as a result of our UltiPro Payment Services, are invested in U.S. Government money market funds that invest in short-term, high quality money market instruments which consist of U.S. Treasury and U.S. Government Agency obligations and repurchase agreements collateralized by such obligations. The money market funds are rated AAA by Standard & Poor's and Aaa by Moody's. Any residual customer funds are held primarily in our bank accounts.
Net cash used in financing activities was $15.5 million for 2018 as compared with net cash provided by financing activities of $29.8 million for 2017. The $45.2 million use in net cash for financing activities was primarily related to a decrease of $3.2 million in cash used to settle employee tax withholding liabilities upon the vesting of their restricted stock awards and restricted stock unit awards, a net use of $42.4 million in customer funds obligations for our UltiPro Payment Services, an increase in cash for the payments of other liabilities of $3.7 million, a decrease of $3.2 million in cash proceeds from the issuance of our Common Stock for stock option exercises, and in principal payments on capital lease obligations of $0.9 million.
Days sales outstanding (“DSO”), calculated on a trailing three-month basis, as of December 31, 2018 were 72 days as compared with 70 days as of December 31, 2017.
Deferred revenues were $239.9 million at December 31, 2018, as compared with $198.9 million at December 31, 2017 due to higher deferred recurring revenues as a result of increased sales.
We believe that cash and cash equivalents, investments in marketable securities, equipment financing, other borrowings and cash generated from operations will be sufficient to fund our operations for at least the next 12 months. This belief is based upon, among other factors, management’s expectations for future revenue growth, controlled expenses and collections of accounts receivable.
As of December 31, 2018, we did not have any material commitments for capital expenditures, except for anticipated capitalized costs associated with the Development Project.

40



Off-Balance Sheet Arrangements
We do not, and, as of December 31, 2018, we did not, have any off-balance sheet arrangements (as that term is defined in applicable SEC rules) that are reasonably likely to have a current or future material effect on our financial condition, results of operations, liquidity, capital expenditures or capital resources.
Non-GAAP Financial Measures
Item 10 (e) of Regulation S-K, "Use of Non-GAAP Financial Measures in Commission Filings," defines and prescribes the use of non-GAAP financial information. Our measure of Non-GAAP Operating Income, which excludes non-cash stock-based compensation, amortization of acquired intangibles, and transaction costs related to business combinations meets the definition of a non-GAAP financial measure.
Ultimate believes that this non-GAAP measure of financial results provides useful information to management and investors regarding certain financial and business trends relating to Ultimate's financial condition and results of operations. Ultimate's management uses this non-GAAP result to compare Ultimate's performance to that of prior periods for trend analyses, for purposes of determining executive incentive compensation, and for budget and planning purposes. This measure is used in monthly financial reports prepared for management and in quarterly financial reports presented to Ultimate's Board of Directors. This measure may be different from non-GAAP financial measures used by other companies.
This non-GAAP measure should not be considered in isolation or as an alternative to such measures determined in accordance with generally accepted accounting principles in the United States (GAAP). The principal limitation of this non-GAAP financial measure is that it excludes significant expenses that are required by GAAP to be recorded. In addition, it is subject to inherent limitations as it reflects the exercise of judgment by management about which expenses are excluded from the non-GAAP financial measure.
To compensate for these limitations, Ultimate presents its non-GAAP financial measure in connection with its GAAP result. Ultimate strongly urges investors and potential investors in Ultimate's securities to review the reconciliation of its non-GAAP financial measure to the comparable GAAP financial measure that is included in the table below and not to rely on any single financial measure to evaluate its business.
We exclude the following items from the non-GAAP financial measure, Non-GAAP Operating Income, as appropriate:
Stock-based compensation expense. Ultimate's non-GAAP financial measure of Non-GAAP Operating Income excludes non-cash stock-based compensation expense, which consists of expenses for restricted stock and stock unit awards recorded in accordance with Accounting Standards Codification 718, “Compensation - Stock Compensation.” For the years ended December 31, 2018, 2017 and 2016, stock-based compensation expense was $140.4 million, $146.4 million and $113.9 million, respectively, on a pre-tax basis. Stock-based compensation expense is excluded from the non-GAAP financial measures because it is a non-cash expense that Ultimate does not consider part of ongoing operations when assessing its financial performance. Ultimate believes that such exclusion facilitates the comparison of results of ongoing operations for current and future periods with such results from past periods. For GAAP net income periods, non-GAAP reconciliations are calculated on a diluted weighted average share basis.
Amortization of acquired intangible assets. In accordance with GAAP, operating expenses include amortization of acquired intangible assets over the estimated useful lives of such assets. For the years ended December 31, 2018, 2017 and 2016, the amortization of acquired intangible assets was $10.1 million, $3.1 million and $1.1 million, respectively. Amortization of acquired intangible assets is excluded from Ultimate's non-GAAP financial measures because it is a non-cash expense that Ultimate does not consider part of ongoing operations when assessing its financial performance. Ultimate believes that such exclusion facilitates comparisons to its historical operating results and to the results of other companies in the same industry, which have their own unique acquisition histories.
Transaction costs related to business combinations. In accordance with GAAP, operating expenses include transaction costs for third-party professional services incurred in connection with business combinations. As we do not acquire or dispose of businesses on a predictable basis, the terms of each business combination are unique and can vary significantly from other business combinations. Significant expenses can be incurred in connection with a business combinations that we would not have otherwise incurred in the periods presented as part of our continuing operations. For the year ended December 31, 2018 there were $3.1 million of transaction costs incurred related to business combination. For the year ended December 31, 2017, there were no transaction costs incurred related to business combinations. For the year ended December 31, 2016 there were

41


$0.9 million of transaction costs incurred related to business combinations. Transaction costs related to business combinations are excluded from Ultimate's non-GAAP financial measures because it is an expense that Ultimate does not consider part of ongoing operations when assessing its financial performance. Ultimate believes that such exclusion facilitates comparisons to its historical operating results and to the results of other companies in the same industry, which have their own unique business combination histories.
 
 
For the Year Ended
 
 
2018
 
2017
 
2016
Non-GAAP operating income reconciliation:
 
 
 
 
 
 
Operating income
 
$
80,596

 
$
44,546

 
$
41,684

Operating income, as a % of total revenues
 
7.1
%
 
4.7
%
 
5.3
%
Add back:
 
 
 
 
 
 
Non-cash stock-based compensation expense
 
140,353

 
146,427

 
113,877

Non-cash amortization of acquired intangible assets
 
10,107

 
3,129

 
1,115

Transaction costs related to business combinations
 
3,059

 

 
874

Non-GAAP operating income
 
$
234,115

 
$
194,102

 
$
157,550

Non-GAAP operating income, as a % of total revenues
 
20.5
%
 
20.6
%
 
20.2
%

Contractual Obligations
As of December 31, 2018, Ultimate’s outstanding contractual cash obligations were as follows (in thousands):
 
Payments Due by Period

Total
 
Less Than 1 Year
 
1-3 Years
 
4-5 Years
 
More than 5 Years
Capital lease obligations (1)
$
12,756

 
$
6,787

 
$
5,969

 
$

 
$

Other long-term obligations (2)
72,228

 
17,359

 
30,458

 
14,157

 
10,254

Other long-term liabilities (3)
4,792

 
4,792

 

 

 

Total contractual cash obligations
$
89,776

 
$
28,938

 
$
36,427

 
$
14,157

 
$
10,254

_________________________
(1)
We lease certain computer equipment under non-cancelable agreements, which are accounted for as capital leases and expire at various dates through 2021. See Note 13 of the Notes to Consolidated Financial Statements included elsewhere in this Form 10-K for information regarding capital lease obligations.
(2)
Included in other long-term obligations were Ultimate’s leases for corporate office space and certain equipment under non-cancelable operating lease agreements expiring at various dates.
(3)
Ultimate has an income tax payable related to the unrecognizable benefit of an uncertain tax position.  As of the date of this report, it is not reasonable to estimate the timing of this payment. Ultimate does not have any other long-term liabilities as of December 31, 2018.
In the ordinary course of Ultimate’s operations, we are exposed to certain market risks, primarily interest rate risk and foreign currency risk. Risks that are either non-financial or non-quantifiable, such as political, economic, tax, or regulatory risks, are not included in the following assessment of our market risks.
Interest Rate Risk. Ultimate is subject to financial market risks, including changes in interest rates which influence the valuations of our fixed income investment portfolio. Changes in interest rates could also impact Ultimate’s anticipated interest income from interest-bearing cash accounts, or cash equivalents and investments in marketable securities. We manage financial market risks, including interest rate risks, in accordance with our investment guideline objectives, including:
Maximum safety of principal;
Maintenance of appropriate liquidity for regular cash needs;
Maximum yields in relationship to guidelines and market conditions;
Diversification of risks; and

42


Fiduciary control of all investments.
Ultimate targets its fixed income investment portfolio to have maturities of 24 months or less. Investments are held to enhance the preservation of capital and not for trading purposes.
Cash equivalents consist of money market accounts with original maturities of less than three months. Short-term investments include obligations of U.S. government agencies, asset-backed securities and corporate debt securities. Corporate debt securities include commercial paper which, according to Ultimate’s investment guidelines, must carry minimum short-term ratings of P-1 by Moody’s Investor Service, Inc. (“Moody’s”) and A-1 by Standard & Poor’s Ratings Service, a Division of The McGraw-Hill Companies, Inc. (“S&P”). Other corporate debt obligations must carry a minimum rating of A-2 by Moody’s or A by S&P. Asset-backed securities must carry a minimum AAA rating by Moody’s and S&P with a maximum average life of two years at the time of purchase.
As of December 31, 2018, total corporate investments in available-for-sale marketable securities were $10.7 million. As of December 31, 2018, total investments with customer funds in available-for-sale marketable securities were $284.3 million.
As of December 31, 2018, virtually all of the investments in Ultimate’s corporate portfolio and portfolio of investments with customer funds were at fixed rates (with a weighted average interest rate of 2.7% and 2.5% per annum, respectively).
To illustrate the potential impact of changes in interest rates, Ultimate has performed an analysis based on its December 31, 2018 consolidated balance sheet and assuming no changes in its investments.  Under this analysis, an immediate and sustained 100 basis point increase in the various base rates would result in a decrease in the fair value of Ultimate’s corporate portfolio of approximately $21 thousand over the next 12 months and a decrease in the fair value of Ultimate’s portfolio of investments with customer funds of approximately of $2.1 million over the next 12 months.  An immediate and sustained 100 basis point decrease in the various base rates would result in an increase in the fair value of Ultimate’s corporate portfolio of approximately $21 thousand over the next 12 months and an increase in the fair value of Ultimate’s portfolio of investments with customer funds of approximately $2.1 million over the next 12 months.
Foreign Currency Risk.  Ultimate has foreign currency risks related to its revenue and operating expenses denominated in currencies other than the U.S. dollar.  Management does not believe movements in the foreign currencies in which Ultimate transacts business will materially affect future net income.

43


INDEX

44


Report of Independent Registered Public Accounting Firm
To the Stockholders and Board of Directors
The Ultimate Software Group, Inc.:

Opinion on the Consolidated Financial Statements

We have audited the accompanying consolidated balance sheets of The Ultimate Software Group, Inc. and subsidiaries (the Company) as of December 31, 2018 and 2017, the related consolidated statements of income, comprehensive income, stockholders’ equity, and cash flows for each of the years in the three‑year period ended December 31, 2018, and the related notes (collectively, the consolidated financial statements). In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 2018 and 2017, and the results of its operations and its cash flows for each of the years in the three‑year period ended December 31, 2018, in conformity with U.S. generally accepted accounting principles.

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the Company’s internal control over financial reporting as of December 31, 2018, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission, and our report dated March 1, 2019 expressed an unqualified opinion on the effectiveness of the Company’s internal control over financial reporting.

Change in Accounting Principle

As discussed in Note 3 to the consolidated financial statements, the Company has changed its method of accounting for revenues and related costs for the year ended December 31, 2018 due to the adoption of Accounting Standards Update No. 2014-09, Revenue from Contracts with Customers (Topic 606), effective January 1, 2018.

Basis for Opinion

These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.

We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud. Our audits included performing procedures to assess the risks of material misstatement of the consolidated financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the consolidated financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. We believe that our audits provide a reasonable basis for our opinion.

/s/ KPMG LLP

We have served as the Company’s auditor since 2002.

Fort Lauderdale, Florida
March 1, 2019



45


THE ULTIMATE SOFTWARE GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
 
As of December 31,
 
2018
 
2017
 
(In thousands, except share data)
ASSETS
 
 
 
Current assets:
 
 
 
Cash and cash equivalents
$
151,247

 
$
155,685

Investments in marketable securities
10,741

 
9,434

Accounts receivable, net of allowance for doubtful accounts of $1,650 for 2018 and $900 for 2017
238,768

 
190,989

Prepaid expenses and other current assets
90,761

 
71,602

Total current assets before funds held for customers
491,517

 
427,710

Funds held for customers
618,206

 
563,062

Total current assets
1,109,723

 
990,772

Property and equipment, net
302,939

 
243,664

Goodwill
219,904

 
35,808

Intangible assets, net
144,411

 
20,862

Other assets, net
129,108

 
53,409

Deferred tax assets, net
14,632

 
32,696

Total assets
$
1,920,717

 
$
1,377,211

LIABILITIES AND STOCKHOLDERS’ EQUITY
 
 
Current liabilities:
 

 
 

Accounts payable
$
16,058

 
$
16,099

Accrued expenses and other liabilities
154,383

 
60,394

Deferred revenue
238,940

 
197,088

Capital lease obligations
6,303

 
5,474

Total current liabilities before customer funds obligations
415,684

 
279,055

Customer funds obligations
619,230

 
564,031

Total current liabilities
1,034,914

 
843,086

Deferred revenue
1,009

 
1,773

Deferred rent
8,472

 
5,349

Capital lease obligations
5,739

 
4,477

Other long-term liabilities
500

 
4,250

Deferred income tax liability
25,105

 
251

Total liabilities
1,075,739

 
859,186

Commitments and contingencies (Note 17)


 


Stockholders’ equity:
 

 
 

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

 

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

 

Common Stock, $.01 par value, 50,000,000 shares authorized, 35,985,995 and 34,787,986 shares issued in 2018 and 2017, respectively
360

 
348

Additional paid-in capital
863,030

 
609,160

Accumulated other comprehensive loss
(14,574
)
 
(5,912
)
Accumulated earnings
207,521

 
125,788

 
1,056,337

 
729,384

Treasury stock, 4,657,995 shares, at cost, for 2018 and 2017
(211,359
)
 
(211,359
)
Total stockholders’ equity
844,978

 
518,025

Total liabilities and stockholders’ equity
$
1,920,717

 
$
1,377,211

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

46


THE ULTIMATE SOFTWARE GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
 
For the Years Ended December 31,
 
2018
 
2017
 
2016
 
(in thousands, except per share data)
Revenues:
 
 
 
 
 
Recurring
$
997,066

 
$
802,300

 
$
654,199

Services
143,478

 
138,429

 
127,092

Total revenues
1,140,544

 
940,729

 
781,291

Cost of revenues:
 

 
 

 
 
Recurring
273,165

 
210,560

 
172,676

Services
158,569

 
143,140

 
127,433

Total cost of revenues
431,734

 
353,700

 
300,109

Gross profit
708,810

 
587,029

 
481,182

Operating expenses:
 

 
 

 
 

Sales and marketing
285,293

 
269,781

 
224,416

Research and development
203,729

 
150,583

 
120,650

General and administrative
139,192

 
122,119

 
94,432

Total operating expenses
628,214

 
542,483

 
439,498

Operating income
80,596

 
44,546

 
41,684

Other income (expense):
 

 
 

 
 

Interest expense and other, net
(693
)
 
(813
)
 
(717
)
Other income, net
3,458

 
397

 
451

Total other income (expense), net
2,765

 
(416
)
 
(266
)
Income before income taxes
83,361

 
44,130

 
41,418

Provision for income taxes
(18,221
)
 
(30,075
)
 
(12,178
)
Net income
$
65,140

 
$
14,055

 
$
29,240

 
 
 
 
 
 
Net income per share:
 
 
 
 


Basic
$
2.11

 
$
0.47

 
$
1.01

Diluted
$
2.06

 
$
0.46

 
$
0.96

 
 
 
 
 
 
Weighted average shares outstanding:
 

 
 

 
 

Basic
30,854

 
29,791

 
28,976

Diluted
31,578

 
30,799

 
30,414

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

47


THE ULTIMATE SOFTWARE GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(In thousands)
 
For the Years Ended December 31,
 
2018
 
2017
 
2016
Net income
$
65,140

 
$
14,055

 
$
29,240

Other comprehensive (loss) income:
 

 
 

 
 
Unrealized gain (loss) on investments in marketable available for sale securities
366

 
(558
)
 
(61
)
Unrealized (loss) gain on foreign currency translation adjustments
(8,882
)
 
1,529

 
843

Other comprehensive (loss) income, before tax 
(8,516
)
 
971

 
782

Income tax (provision) benefit related to items of other comprehensive income
(146
)
 
140

 
24

Other comprehensive (loss) income, net of tax
$
(8,662
)
 
$
1,111

 
$
806

Comprehensive income
$
56,478

 
$
15,166

 
$
30,046

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

48


THE ULTIMATE SOFTWARE GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(In thousands)
 
Common Stock
 
Additional Paid -in Capital
 
Accumulated Other Comprehensive
(Loss) Income
 
Accumulated
Earnings
 
Treasury Stock
 
Total Stockholders’
Equity
 
Shares
 
Amount
 
 
 
 
Shares
 
Amount
 
Balance, December 31, 2015
33,261

 
$
333

 
$
463,609

 
$
(7,829
)
 
$
42,747

 
4,468

 
$
(181,674
)
 
$
317,186

Cumulative impact of adoption of ASU 2016-09

 
 
 
 
 
 
 
 
39,746

 
 
 
 
 
39,746

Net income

 

 

 

 
29,240

 

 

 
29,240

Unrealized loss on investments in
marketable securities available-for-sale, net of tax

 

 

 
(37
)
 

 

 

 
(37
)
Unrealized loss on foreign exchange

 

 

 
843

 

 

 

 
843

Shares acquired to settle employee tax withholding liability

 

 
(65,522
)
 

 

 

 

 
(65,522
)
Repurchases of Common Stock

 

 

 

 

 
190

 
(29,685
)
 
(29,685
)
Stock consideration for acquisitions
7

 

 

 

 

 

 

 

Issuances of Common Stock from exercises of stock options
183

 
2

 
4,657

 

 

 

 

 
4,659

Issuances of Common Stock from restricted stock releases
552

 
5

 

 

 

 

 

 
5

Non-cash stock-based compensation expense

 

 
117,780

 

 

 

 

 
117,780

Balance, December 31, 2016
34,003

 
$
340

 
$
520,524

 
$
(7,023
)
 
$
111,733

 
4,658

 
$
(211,359
)
 
$
414,215

Net income

 

 

 

 
14,055

 

 

 
14,055

Unrealized loss on investments in marketable securities available-for-sale, net of tax

 

 

 
(418
)
 

 

 

 
(418
)
Unrealized gain on foreign exchange