The Ultimate Software Group, Inc. Q4 2008 Earnings Call Transcript

The Ultimate Software Group, Inc. (ULTI)

Q4 2008 Earnings Call

February 5, 2009 5:00 pm ET

Executives

Scott Sherr – Chairman of the Board, President & Chief Executive Officer

Mitchell K. Dauerman – Chief Financial Officer, Executive Vice President & Treasurer

Analysts

Terry Tillman – Raymond James

Michael Nemeroff – Piper Jaffray

Richard Davis – Needham & Company

Dan Cummins – Soleil-Lime Rock Research

Richard Bladry – Canaccord Adams

Steve Koenig – Keybanc Capital Markets

Mark Marcon – R. W. Baird & Co., Inc.

Nathan Schneiderman – Roth Capital Partners

David Cohen – JP Morgan

[Analyst for Brad Lit – Broadpoint Amtech]

Franco Turrinelli – William Blair & Company, LLC

Analyst for Tom Ernst – Deutsche Bank Securities

Presentation

Operator

Welcome to Ultimate Software’s fourth quarter and yearend financial results conference call. At this time all participants are in a listen only mode. Today’s conference is being recorded. The presenters today will be Mr. Scott Sherr, Chief Executive Officer President and Founder of Ultimate Software and Mitchell Dauerman, Executive Vice President and Chief Financial Officer.

We will begin with comments from Mitchell Dauerman.

Mitchell K. Dauerman

Before we begin please be aware that we will be discussing our business outlook and we’ll be making other forward-looking statements regarding our current expectations and the future financial performance of the company. These forward-looking statements are based on information available to us as of today’s date and are subject to risks and uncertainties.

We encourage you to review our filings with the SEC at www.SEC.gov for additional information on risk factors that could cause actual results to differ materially from our current expectations. We assume no duty or obligation to publically update or revise any forward-looking statements whether as a result of new information, future events or otherwise.

I’m going to discuss the financial results for 2008 and then update our financial guidance for 2009. Unless otherwise noted, our discussion will be on a non-GAAP basis for all costs, gross margin, operating and net income as well as EPS when compared to the same period in the prior year. The primary difference between GAAP and non-GAAP financial information is non-cash stock-based compensation. Please refer to the reconciliation of the financial information on a GAAP basis to that on a non-GAAP basis attached to the press release published on our website.

Our ARR for the quarter was $12 million and for the year was $41.3 million representing a 33% year-over-year increase. Recurring revenues for the quarter were $28.9 million and for the year were $106.7 million, a 19% increase for the quarter and a 23% increase for the year. Total revenues for the quarter were $49.7 million and $178.6 million for the year growing 18% for both the quarter and the year.

Non-GAAP net income of $2.7 million or $0.11 per share for the quarter and for the year was $7.1 million or $0.27 per share. For Q4 our recurring revenues of $28.9 million came in towards the high end of the guidance we provided in October. Our time to live period for our Intersourcing sales remained in line with our expectations.

The attrition rate for our Intersourcing customers was consistent with Q3 at a 3% [inaudible] and we continue tracking our employee growth rate through our existing Intersourcing customer base using a same store sales type of financial metrics and we found that the employees counts of our consolidated existing customer base for 2008 grew by 1% over 2007 and 52% of our client companies grew in size of the 2008 year.

Service revenues for Q4 were $18.3 million which was at the lower end of our October guidance. We completed a large project in the fourth quarter which we discussed on the last call using third party implementation partners to help clear the backlog. We also recorded the services revenue from our first National [inaudible] Group meeting.

While our implementation rate per hour remained consistent with Q3 our existing customers began to defer the start date of elective work that historically has produced billable hours that are incremental to the basic implementation of our UltiPro solution. In addition, we’re beginning to see new customers take on more of the project hours internally. While the impact on Q4 was relatively small we still expect to see more of an impact in 2009 as I’ll discuss momentarily.

We believe that customers’ spending patterns for incremental implementation work may be a result of the current economy in the same vain that we also experienced reduced participation from customers attending training classes thus putting pressure on training revenues for this quarter. We expect that to continue in to 2009.

License revenues were $2.5 million for the quarter. As I will discuss later, after the first quarter of 2009 we will cease selling on-site UltiPro solutions on a perpetual license basis. Although, we will continue to sell these onsite solutions on a subscription or recurring revenue basis.

Turning to the cost of revenue and gross margin side of our Q4 results. Recurring revenues costs were in line with our expectations, service costs were slightly higher than our expectations due to higher variable costs mostly associated with increased sales of time clocks for our time management solution. Service margins were lower than we expected principally due to the lower training revenues from decreased classroom attendance in the quarter. However, gross margins from all revenue services both in dollars and as a percentage were in line with our expectations.

On the operating expense side, our expenses were in line with our expectations other than sales and marketing. Sales and marketing costs were about $300,000 higher than our expectations driven by higher commissions associated with the higher license revenues as well as continued investments in the sales organization. Operating margins were 9% compared to our guidance of 9% to 10% for the quarter.

Turning to the balance sheet, total cash and investments in marketable securities were $23 million at the end of December. We generated $6.9 million in cash from operations for the quarter and $25.5 million for the year. We invested $3.7 million in total capital expenditures during the quarter bringing the total for the year to $16 million. As a part of our stock repurchase program, we used $5 million in the quarter to acquire 358,000 shares of our common stock. For the year we used $26.7 million to acquire 1,810,000 shares of our common stock.

Finally, we will update the preliminary guidance for 2009 and discuss our expectations for Q1 of 2009. For the year 2009 we expect new ARR growth to be 30%. As I previously mentioned we made the business decision to begin selling on premise UltiPro solutions on a subscription basis only beginning April 1, 2009. As a result, license revenues are estimated at $2 million for the first quarter and zero for the balance of the year.

Recurring revenue growth is expected to be in the 27% to 30% range. This takes in to consideration both lower maintenance revenues from incremental perpetual license sales as this is a function of the discontinuance of the perpetual license sales after Q1. In addition, we made adjustments for Intersourcing revenues for customers’ employment growth, attrition and price increases in our model in response to recent economic times.

Recurring revenue gross margins will be in the 69% to 70% range. The recurring revenue margin will be impacted by our business decision to stop selling perpetual license since certain costs previously allocated to the cost of license will instead be allocated to cost of recurring revenues thus impacting comparability to prior periods. In 2009 recurring costs will also reflect incremental amortization of capitalized software for purchase source codes as well as our investment in our tax filing business.

As I mentioned earlier, we are expecting less implementation revenues from sales and services back to our existing client base which in the past has been significant. However, currently we believe customers are viewing these types of services as more discretionary and in addition we expect new clients will take on more of the implementation hours themselves and we also expect to use significantly less third party implementation partners than we did in 2008. Consequently, we’ve adjusted our service revenues expectation and only expect to see modest growth in services revenues of 5% to 8% for the year while we expect to see improving services margins in the 23% to 25% range.

Total revenue should grow between 13% and 15% as we make the transition to eliminating perpetual license revenues after Q1 of ’09. Blended total gross margin should be around 55% to 56%. We expect our operating expense growth rate to be around 12% as we expect to leverage the R&D investment we made in 2008 during 2009. We incurred certain significant third party costs for R&D during 2008 which we do not plan to repeat in 2009 to the same extent.

Operating margins of 6% to 7% should be produced for 2009. At a high level, the changes from our prior guidance for 2009 can be summarized as: one, a 2.5% reduction due to the changes in our perpetual license revenue expectation; two, a 1% reduction from adjustments from recurring revenues to incorporate a more conservative outlook with regards to our existing Intersourcing customer base and our expectations for the related growth in employee size, attrition, etc.; and three, a .5% effect attributable to the growth in our workplace sales organization.

Another way to look at our operating margins for 2009 is to normalize both 2008 and 2009 by removing the impact of license revenues and the related costs as well as the Ceridian transaction in which case the 2009 operating margins will expand by about 500 basis points as a result of the incremental operating margin contribution of approximately 28%. Taking in to consideration the current interest rate environment on our cash investments we’re estimating our net investment income at close to zero.

We expect our non-GAAP effective tax rate to be between 39% and 40% while the cash tax rate should remain in low single digits. We expect stock-based compensation and the amortization of acquired intangibles will be approximately $13.5 million. Beginning in 2009 the company revised its equity compensation plan and new grants to our employees will be issued as restricted stock units instead of non-qualified stock options. We expect 2009 capital expenditures will be approximately $12 million and diluted weighted average shares should be approximately $26 million.

Next I’d like to discuss our guidance for Q1 of 2009. We expect ARR to grow approximately 30% over the same quarter of 2008. We expect our recurring revenues to be between $30 and $31 million and this takes in to account seasonable employment patterns of our customer base. Our services revenues are expected to be between $16 and $17 million. We are forecasting license revenues of $2 million.

Also, as a reminder for year-over-year comparative purposes, the first quarter of last year included $1.5 million of recurring revenues related to the Ceridian transaction which ended in mid March of last year. Looking at our costs on a sequential quarter basis Q1 ’09 versus Q4 of ’08 will have higher costs which is the usual pattern each year and it’s mostly due to employment related expenses, particularly higher benefits, typical of the beginning of each year when compared to the fourth quarter and prior year. In addition, Q1 will reflect the incremental amortization of capitalized software for purchased source code that start amortizing in 2009.

Taking these items in to account, we expect gross margins for recurring revenues to be between 69% and 70% and service margins to be around 26% to 27%. Total operating expenses will be between $24.5 and $26 million for the first quarter. Sales and marketing should be between $12 and $13 million reflecting additional headcount from our workplace sales organization, our national sales meeting and performance based sales club held in Q1 as well as higher payroll taxes and benefits.

R&D Should be around $9 to $9.5 million and G&A should be approximately $3.5 million. We expect to produce operating margins of approximately 4%. Keep in mind when comparing to the same quarter last year that license sales are estimated to be approximately $1.7 million lower and Q1 of 2008 also included $1.5 million of recurring revenues from the Ceridian deal that terminated in mid Marc of last year.

Turning to our upcoming conference schedule, during the next quarter on February 25^th I’ll be at the Baird’s 15^th Annual Business Solutions Conference in Boston. On March 9^th the Raymond James Annual Institutional Investors Conference in Orlando and on March 12^th the Wedbush Morgan 7^th Annual New York City MAC Conference. If you’re available at those conferences to meet, please let me know.

Now, I’ll turn the call over to Scott.

Scott Sherr

We closed the 2008 year with a strong fourth quarter. The best indicators of our sales results is new ARR and those were $12 million in the fourth quarter, a record quarterly performance for us. That made our growth rate in new ARR for 2008 33% as compared with 2007 new ARR. Another metric that reflects our continuing success in the marketplace is the increase in our number of units from new customers.

While we do not share the actual numbers of units I can tell you a growth percentage. For the 2008 year we sold 40% more new customer units than we did in 2007. Our enterprise team is the foundation of our business strategy and they finished 2008 with more than 100% of plan. This is their fifth consecutive year to finish above plan. A key to their success has been the attach rate for our add on solutions. I have not given precise attach rates for a while but this time I want to share some numbers to give you a better sense of how they’re not executing.

In the fourth quarter the enterprise team produced a 65% attach rate for recruitment, 44% for performance management and 37% for [inaudible]. [Inaudible] remained consistent at 25%. We believe that companies need our products now more than ever and the market seems to agree with us.

Another positive is the continuing trend towards larger customers in our enterprise sector. For the fourth consecutive quarter 50% of our new enterprises ARR came from companies larger than 3,000. Our strategic growth plan is clearly working. 65% of the enterprise team achieved their annual goals. The average tenure of the quoted carriers is more than eight years with us and the average tenure for sales management is greater than 10 years.

This kind of experience and obvious commitment to Ultimate is a major asset for us. In January, I spent time with all of them at our annual meeting. They are very confident that they can continue the momentum and achieve their 2009 goals. The workplace team our growth engine exceeded all our expectations in 2008. We started 2008 with just three quoted carriers. We opened 2009 with 20.

We do not make a practice of sharing number of units and will not routinely do so. But, I believe it is appropriate to give you some specific numbers today to illustrate the strength of their achievement. In 2007 the workplace team sold 32 new units. In 2008 they sold 142 units. Again, we are not going to give attach rates on every call but today I am going to follow up on the numbers that I gave you last quarter so you can see how the smaller companies are still buying in to the holistic approach to managing people that we are offering with our solutions.

The Q4 attach rate for tax management was $100 %, for time management 71%, for recruitment 59% and for performance management 45%. The workplace team contributed 23% of the new ARR for the fourth quarter and 18% of the new ARR for the 2008 year. This is a very talented team with strong leadership. I met with the workplace team as well at their meeting in January and they too are extremely excited about the opportunity they have. They’re goal is to achieve more than 30% of our new ARR in 2009 and they are on tract and confident about meet aiding or exceeding their goals.

Our strategy to grow our market presence through UltiPro workplace is well on its way and gaining momentum. The workplace solution sets a new standard in the industry for small and midsized businesses. It’s a real breakthrough in the HR market in terms of what it delivers giving these businesses access to a complete suite of talent management solutions as well as a top rated core HR and payroll solution that only larger companies have been able to afford in the past.

This quarter we reached the exiting milestone of 1,000,000 employees live in our Intersourcing Software-As-A-Service environment. Our track record of 99.9% uptime continued in the fourth quarter and as Mitch noted we maintained our 97% retention rate. Our customer reference list continues to grow and the wide spread satisfaction with UltiPro is the fuel for our growth.

I’ll give you a quick sampling of recent quotes from our customers. The director of corporate staffing and compensation from Jockey International the well known clothing company with approximately 5,000 employees said, “UltiPro’s reporting is incredible. With UltiPro our HR and payroll team can compile metrics and deliver them to executives much faster than when we were using a service bureau.” The senior manager from employee facing applications at Herman Miller, a leading global provider of office furniture and services said, “With UltiPro we have a system that brings with it years of best practices for processes, compliance and more. Since we started using UltiPro we have much less tactical work on our plate and we have been able to realign resources to more strategic and value added activities.”

The vice president of human resources and labor relations at San Diego Convention Center said, “Ultimate Software has given me peace of mind knowing that I have one provider centralizing our employee related information. Prior to UltiPro the multiple solution we used along with the different custom interfaces we created were like a house of cards that we feared could fall at any time. Now, our HR operations are much more effective and efficient with one vendor and Software-As-A-Service convenience.”

Vice president of human resources from Anheuser-Busch Employees Credit Union said, “With employees in 26 locations throughout the country we need the integrated functionality that UltiPro delivers to centralize and streamline our processes, empower our employees with self service access to their information. UltiPro maximizes the contributions that [inaudible] to the business using consolidated workforce reporting.”

A payroll administrator from Tropical Financial, a financial cooperative said, “Since we’ve moved from a service bureau to UltiPro I can breathe. I complete my work in a fraction of the time because UltiPro can handle our complexity with ease.” A HR IS analyst from Compassion International said, “UltiPro’s recruiting and hiring functionality is extremely valuable. With the economic downturn we are seeing a huge increase in job applications. Our organization has double digit numbers of positions that need to be filled very quickly. UltiPro enables us to view 100 applicants at a time, evaluate each person’s entire history and then conveniently send relevant information to the right hiring managers without the delays associated with paper forms.”

In closing I want to return to the topic of our headcount and growth. As I said on the last call, we accelerated our new hire program in the third quarter to accommodate our higher than expected new ARR growth in the first nine months of the year. As of December 31 we are 929 strong. Our primary goal is like that of every business I believe, to keep getting better at what we do. We have invested in what it takes to have the industry’s best products and will continue to do so.

We are focused at getting better at customer support, better at distribution, better at marketing and articulating the value of our solutions and above all else we are focused on keeping our exceptional company culture. It is our employees who must be passionate about our products and services. They are the ones who make excellence happen, they are the ones that can keep us ahead of our competition and provide our customers the type of services that can’t be found anywhere else.

In good times and bad our UltiPro solutions help companies manage their most important asset, their employees. Now, more than ever, businesses can benefit from the exceptional set of tools we offer for managing their talent efficiency and strategically. Ultimate is in a good position to continue executing on our growth plan and we are looking forward to working alongside our customers to help them be successful as well.

Last, I want to thank our employees for the successes they have already given us and in particular for the many honors they brought us in 2008: first, Ultimate’s recognition as the first HR Software-As-A-Service provider to be awarded the ISO certification for security management; second, Ultimate’s customer support center being award SCC certification for best practices for the 10^th consecutive year; third, Ultimate’s development team being named the best product development team in the United States by the American Business Awards; next, the recognition of Ultimate as the only HR system provider to merit the title of leader in the United States market by Forrester Research and Wave analysis of HR systems and to be also named a leader in the multinational enterprise space; and finally, Ultimate being ranked the number one best medium sized company to work for in America by the Great Place To Work Institute.

What a great honor to receive the award in front of 15,000 HR professionals at the annual SHRM conference and equally exciting to share the state with Laszlo Bock, vice president of people operations at Google, the Great Place To Work Winner for companies with more than 1,000 employees.

These are exciting times for us at Ultimate and we all look forward to executing on the huge opportunity before us. Let’s go to the Q&A.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Terry Tillman – Raymond James.

Terry Tillman – Raymond James

In terms of the ARR in the quarter, I mean that’s notable, the record quarter and I think it was up like 10% or so year-over-year but I am wondering in the quarter itself did you see any kind of market change maybe within the quarter in terms of close rates or something that just reflected this new world that we live in? Maybe you can answer that and then I’ll ask it on a non ARR.

Mitchell K. Dauerman

First, the answer is no. We are modeling and our quotas were based on us doing $12 million. The fact is we just happened to go over quota in Q1, Q2 and Q3. Workplace was a little above 100% of quota for the quarter and enterprise was a little below 100%. We were expecting in our model and what we quoted $12 million in Q4.

Terry Tillman – Raymond James

Then in terms of the ARR assumption for ’09 it seems like each quarter for all my companies the next quarter out is getting much more tougher from a macro perspective so why not take the air a little bit out of the ARR growth guidance. I mean it’s admirable but if there’s some challenges then we’re going to have more issues on this recurring revenue growth in ’09 so why not be more conservative as opposed to sticking with that 30% ARR assumption?

Mitchell K. Dauerman

I did take the air out of it. I mean, our sales team has not missed for five years. Workplace is a first year. Quite frankly, if our team comes in at quota which I have no reason to believe they’re not going to come in at quota, we will achieve more than that.

Terry Tillman – Raymond James

Then Mitch just a question in terms of the new 6% to 7% operating margin assumption, you went through a lot of detail so I appreciate the impact there. The one thing though is if I look at my three op ex line items can you help me again and maybe you did say this and maybe I missed it but how should we think about on a percent of revenue for sales and marketing, R&D and G&A for ’09?

Mitchell K. Dauerman

Terry, you’re probably in a 22% to 23% range for sales and marketing, R&D 18% to 19% and G&A is probably around 7.5% to 8%.

Operator

Your next question comes from Michael Nemeroff – Piper Jaffray.

Michael Nemeroff – Piper Jaffray

Just a couple of brief ones, one for Mitch, when you moved the $6 million of license out of the model, obviously I would have thought the ARR would have increased a little bit more because of the license being converted to ARR. I guess following up on Terry’s question is that the conservatism that maybe he was looking for is taking a little bit out of what would have been license that would have gone in to ARR?

Mitchell K. Dauerman

Yes.

Michael Nemeroff – Piper Jaffray

Then also if you could just help us maybe Mitch with the long term targets now that the model has shifted a little bit with the 6% or 7% margin this year. What can we expect going forward for margin improvement?

Mitchell K. Dauerman

I think Mike that we’re still on track to hit our goal of $400 million of revenues in 2012. It’s basically built on growing ARR after this year at a 25% rate. We expect to hit operating margins in 2012 we think still at the 25% rate and kind of on the interim step. The reason I commented on kind of normalized operating margins is I think what you’ll see is this year picking up to 500 basis points in the operating margin on a normalized basis and then next year that accelerates even more.

It’s obviously way too soon to start talking about 2010 guidance but based on the way we’re looking at it, we think operating margin contribution could be close to a 40% range which would again expand the margins as we go forward. Again, I think as we get to 010 we’ll be on a pretty comparative basis to ’09.

Michael Nemeroff – Piper Jaffray

Just one last one if I may, the new onsite subscription licenses, what kind of durations are you going to be selling on those?

Scott Sherr

It will be a three year contract that we do and then it will be renewable after three years.

Operator

Your next question comes from Richard Davis – Needham & Company.

Richard Davis – Needham & Company

With regard to the attach rates which I think were interesting and the modules themselves were good. Historically I think a lot of the modules that you would add like that would be replacement of best legacy processes and in many cases paper. Is that still the case? And, I have to imagine that in the mid and small market that [inaudible] is much more paper but I just wanted to see if that’s the case? Then, the ancillary question is have you run in to there’s a gaggle of the point solution vendors out there that have one specific item that you guys compete with or not and have you run in to them? And, have you won or loss? And, are you replacing them?

Scott Sherr

We look at our competitive landscape and those point solutions we don’t run in to. If someone says, “We have one of those point solutions.” We say okay this is what we have and if some change in the future you want to be integrated to UltiPro if you chose to go with us. Whenever we looking at a different module we need to get 25% attach rate on new sales and we feel that’s good. Obviously, we’re over achieving on that.

The first part of the question I just think everyone is trying to get paperless, whether it’s an enterprise customer or a workplace customer, we see more and more customers trying to do that. We do that in Ultimate, we’ve been doing it for years. A lot of our customers are paperless so we’re certainly selling that as part of how UltiPro can help the organization.

Mitchell K. Dauerman

[Inaudible] I would say the customers who are coming over, I think you were asking about those point solutions, they’re not coming over typically from another point solutions. I think as Scott said. They’re doing it and whatever they’re doing, they’re doing it in another way and we’re providing a way that’s more efficient for them and more integrated with the whole system.

Operator

Your next question comes from Dan Cummins – Soleil-Lime Rock Research.

Dan Cummins – Soleil-Lime Rock Research

A couple of questions, I’m sorry I missed the cap ex projection for 2009. The second question is what do you envision for share repurchase activity for ’09? Does your decision to go to restricted stock affect that in any way? And, I had a clarification question on the productivity in the workplace segment?

Mitchell K. Dauerman

Cap ex is $12 million for 2009. Share repurchase activity there’s really nothing modeled in to it for now. We’re going to monitor it quarter-to-quarter as we always have looking at our cash balance we want to keep on the balance sheet. The decision to go to restricted stock doesn’t really affect it. The decision to go to restricted stock was kind of a migration we started back in 2005 where the senior management went to restricted stock as well as the board and we know at some point we would convert options in to restricted stock but again, preserving what we firmly believe it is important that everybody has some ownership in the company.

Dan Cummins – Soleil-Lime Rock Research

Then on the workplace, the QDR headcount I thought was close to 20, maybe high teens six months ago and I think you said they contributed 23% of ARR for the full year last year?

Scott Sherr

Q4, 18% for the full year.

Dan Cummins – Soleil-Lime Rock Research

I’m sorry did you say the contribution targeted for 2009 is 30% of ARR?

Scott Sherr

Yes.

Dan Cummins – Soleil-Lime Rock Research

Are you using roughly similar or less productivity just given the macro environment for these guys?

Scott Sherr

We’re using the number – the three quoted carriers that started with us in 2008, if you took what they averaged in quota, that’s the quota that we’ve given everyone.

Dan Cummins – Soleil-Lime Rock Research

Those are mighty producers.

Scott Sherr

I have 20 mighty producers. No one comes to us unless they’re a mighty producer.

Operator

Your next question comes from Richard Bladry – Canaccord Adams.

Richard Bladry – Canaccord Adams

Can you talk a little about the targets of where you might expect to have headcount for quota carrier and workplace either throughout or by the end of ’09? Then, more on the financial front for Mitch I guess, whether you’ve got a free cash flow number for ’09 that you could share? Then maybe talk a little about I didn’t think pro forma you had a higher tax rate typically as we saw you had a Q4 EPS number factored in and then are reminder on the ’09 taxes both I guess cash and [inaudible]?

Scott Sherr

I’ll start with workplace. When we higher workplace sales persons we quoted them in the seventh month so a lot of them have contributed before their seventh month and I think that’s one of the reasons we contributed so much. We thought we’d be between 15% and 20% for the year, we ended up at 18%. Our goal was to go in to this year with 20 quota carriers and our goal to go in to 2010 is 38 full quota carriers. That means they’re on full quota at January 1.

Mitchell K. Dauerman

Rich, on the free cash flow, kind of a general guideline is free cash flow get’s pretty close to pro forma operating income before taxes. Probably a little bit higher but probably to give ourselves some wiggle room I say let’s start with that as a base and it could be a little bit higher. Then, as far as our tax rate, the 39% to 40% is consistent. I think this year on pro forma we were probably around 39.1%, 39.2% and that should be like I said consistent next year.

Richard Bladry – Canaccord Adams

It looks like on your Q4 calculation of non-GAAP EPS that you have something at I think a 34%, 35% tax adjustment on it. I’m not sure if that’s consistent with what you’ve done in the past or if there’s some reason for that and how you’d calculate for it going forward?

Mitchell K. Dauerman

No, there’s nothing unusual. You basically start with your GAAP tax rate is then you know what your non-GAAP rate is and then the taxes associated with the non-GAAP adjustments is the difference so that may be where it’s coming from.

Operator

Your next question comes from Steve Koenig – Keybanc Capital Markets.

Steve Koenig – Keybanc Capital Markets

I have one question and one follow up if I may. On the ARR number, I’m wondering the ARR growth in Q4 was below other quarters and you talked a little bit about your assumptions next year and what goes in to that assumption but what can give you the confidence that the year ended growth this quarter that that isn’t a trend that reflects the economy that will be accelerated somehow?

Scott Sherr

It’s simply making quota. That was our number in Q4. They overachieved the previous quarters. If you went back the previous year we said that we were geared up for the huge Q4 in 2007 at that time which was our quota when we said we were underneath the guidance and then we came up and hit it. It’s just quota. You assign quota and you assign people as they come in and then you have a lag as to when people come in and you get to this quota number.

The fact is, as I said the enterprise team has hit quota for five straight years. The workplace team this is really their first full year as a team with a number but right now I have no reason to believe that either team will no obtain quota and I did put room in from the 30% from the main quota. I have no reason to believe that they won’t hit quota because it comes down to one workplace [inaudible] in the State of Florida so one [yellow] month. As a workplace, [Larry O’Keefe] was doing in 14 years in the State of Florida 45 enterprise units that he’s been doing for us forever.

You take that to 25 enterprise help people, you take that to 20 full quota carriers that we have now that have been with us because remember we do not quote it until the seventh month so we have a very good look at these people. We’ve seen them produce, we’ve seen how they are. Obviously we would not have hired them if we didn’t think they were special. If our sales team misses it will be the first time they’ve missed in five years and I just don’t see that happening.

Steve Koenig – Keybanc Capital Markets

If I may I’d like to follow up with one question, concerning the opportunity pipeline can you talk about if you see any impact in terms of the economy how it’s impacting the nature of the opportunity? I know your pipeline comes is a variety of types of prospects including turnover from ADP or Ceridian or people with packaged software installed, etc. Are you seeing the nature of that pipeline change or the rate of acquiring pipeline opportunities change at all?

Scott Sherr

As I’ve been saying for a while now, we’re seeing more and more people show up at our seminars. We just did on January 27^th we did what we call an HR Power Clinic where we invite some of our prospects and some of our customers to a session. That was January 27^th in Detroit and we did January 28^th. We had over 100 companies at each. We have a thing out west, I’m not going to give the City but we have well over 100 companies coming February 10^th. The seminars we had at the end of last year.

HR is a big thing, managing your people is a big thing, recruiting is a big thing and I think like I said in good times and in bad times it matters how you recruit people and how you keep the quality people in your organization and that’s what we do. We’re seeing more people come to the events we’re having than a couple of years ago.

Operator

Your next question comes from Mark Marcon – R. W. Baird & Co., Inc.

Mark Marcon – R. W. Baird & Co., Inc.

Can you talk a little bit about the strategic reason for moving away from the perpetual license? What are you seeing from your clients in terms of are you getting a sense, obviously Software-As-A-Service is a well accepted trend but you had a good quarter in terms of the perpetual deals this quarter so I was just wondering what you were seeing? Then, the follow up to that is how should we think about pricing for the new type of onsite solution?

Scott Sherr

I think clearly mainly 97% of our ARR in Q4 came from our staff solution, 96% in Q3. When we looked at the second half of the year to the second half of last year it was down, that’s why we guided from $4 million to $2 million in license. I think it was time to offer on premise one, for those few companies that for their own particular reason decide that they have to be on premise so we don’t want to leave them out so we just thought, “Hey now is a good time to get away from perpetual license.”

In an economy like this it gives them an easier entry point to get in to Ultimate Software and from our standpoint you take a short term hit and a long term gain. As far as the pricing of it, I’m not going to go there but it’s less than hosting which we would do. It’s everything we put for that client, take a hosting with us because we think it’s a better solution, but it’s less than our hosted solution.

Mark Marcon – R. W. Baird & Co., Inc.

Scott, there’s been terms of the 30% ARR growth, essentially you’re including this on premise on there so that’s part of the reason why you would have the confidence that you would have the growth, correct?

Scott Sherr

That’s a part of it. It’s a part of it and the other thing I just again, it’s having the 20 workplace people on quota having the enterprise team coming off a good year. It’s a client based sales team that hasn’t missed in I can’t remember when, it’s having confidence in your sales team and also when you take each component of the sales team we’re not really increasing it that much. That’s why we call workplace the growth engine.

We’re really asking enterprise to do, the senior people to do almost exactly what they did, maybe a little more. We’re asking the client based people to do exactly what they did, maybe a little more. Then, we’re asking the new workplace people to be successful and to be successful they have to sell one 350 employee account or solution in a territory and the people that we have hired there’s not one that would look you in the eye that would think that they can’t do that, one a month.

Operator

Your next question comes from Nathan Schneiderman – Roth Capital Partners.

Nathan Schneiderman – Roth Capital Partners

I had a question for you Mitch related to a comment you made that the workplace investment was going to have the 0.5% negative impact on operating margin. I was just curious what specific aspect of that was stepped up relative to your prior plan or the ending 38 reps you were talking about is that a higher number than you planned? Just where is the incremental investment?

Mitchell K. Dauerman

Our plan was to enter ’10 with 29 and to enter ’11 with 38 and I accelerated it. It was only 29 in ’10 and then the 38 in ’11 but we’ll have 38 full quota carriers going in to 2010.

Nathan Schneiderman – Roth Capital Partners

You told us that you made some conservative assumptions about same customer employee growth or your same store sales that’s actually the number of employees covered versus the year ago. Can you talk about the changes to your assumptions? Are you planning for absolute declines and in what magnitude in your new assumptions?

Mitchell K. Dauerman

We obviously are building more conservatism in to the model. As I said before we were net 1% growth for the year but I built in a 4% decline from beginning to end of the year. I think everyone will have a different estimation of what it should be but we put that in, we think it’s a reasonable number and we’ll monitor against it.

Nathan Schneiderman – Roth Capital Partners

Final question for you, I was just curious if there are any new product drivers coming on board in 2009 that you would highlight? I guess in that if you can give us an update on any [inaudible] you’re having with Canada or the UK at this point?

Scott Sherr

There’s no new product drivers, we’re exactly where we want to be right now, just making what we have better. We’ve been to Canada, we’ve been successful. We have a very good person up there and they’ll contribute exactly what we want them to contribute. There is no new business in the UK, there never has been. We never expected any new revenue in the UK and we don’t have any in our plans.

Operator

Your next question comes from David Cohen – JP Morgan.

David Cohen – JP Morgan

It sounds like the pricing environment has become very aggressive. ADP talked about that there’s a lot of aggressive pricing. Can you talk about what you’re seeing in terms of the pricing and how you’re managing such an environment?

Scott Sherr

We sell value, we sell what we have, we think we have something where we can prove ROI on every deal we go in to from what they’re using. I think HR departments use us to make their HR department better. So, once we get in front of the head of HR and they chose to let us in front of them and we show them what we have and how UltiPro can help them, we close over 90% of those deals. Any deal that we do we can prove ROI. So we’ve never not been able to prove ROI.

We’re always in a deal where they’re using something else. Obviously, we’re over 200 employees so they’re using something to do their HR payroll. Some of them don’t have any talent management solutions, some of them don’t have time and attendance solutions so that just adds to it. But, in the history of Ultimate we’ve never had a problem proving ROI once we got to the point that we can show them that our solution can help their company. I don’t see anything changed for us there.

David Cohen – JP Morgan

Are your competitors getting more aggressive on pricing but you’re still able because of the ROI proposition to win the business?

Scott Sherr

When I talk [inaudible] mainly our competitors David [inaudible] free implementation and a year free. So they haven’t done any worse than that.

David Cohen – JP Morgan

Just a quick question, the [funds flipper] clients is still a small number but it was up quite a bit on the balance sheet. Was that just timing with when the quarter ended? What’s sort of driving that?

Mitchell K. Dauerman

It would be the timing on payrolls and as we’re adding more and more customers’ funds is going to go up even higher.

Operator

Your next question comes from [Analyst for Brad Lit – Broadpoint Amtech].

[Analyst for Brad Lit – Broadpoint Amtech]

A few quick questions, the first what are your expectation in terms of churn holding up in ’09? Second, is it possible for a customer at a time say six months or so ago that has yet to go live to ask for a lower price due to layoffs that occurred since they signed a contract?

Mitchell K. Dauerman

Typically a customer is going to go live and it’s going to be based on their contracts. With that being said, I don’t know how much you know about Ultimate but we do the right thing in looking at a situation.

[Analyst for Brad Lit – Broadpoint Amtech]

The first part was just in terms of Churn rates holding up in ’09, what are you expectations there?

Mitchell K. Dauerman

Our expectation is around 3%. We’ve been holding that for the last couple of quarters. We think the combination of that churn rate as well as what I mentioned before about net shrinkage is a reasonable estimate for what is going to happen during the year.

Operator

Your next question comes from Franco Turrinelli – William Blair & Company, LLC.

Franco Turrinelli – William Blair & Company, LLC

I guess I have two separate questions here, can you remind me on the license fee how that was priced? Where I’m going is I’ve heard a couple of other questions that seem to indicate that the ARR forecast should be higher for ’09 because license fee revenues is going to turn in to recurring revenue. But, I don’t know what people have forecasted but if we take your first quarter run rate for revenue, say we’re going to lose about $6 million of license fee revenue how much ARR would that have been? It’s a pretty tiny amount, isn’t it?

Scott Sherr

When you get after the $6 million you’re talking about 20% so you’re talking about $1.2 million in recurring revenue which is less important so you’ve got to take recurring revenue and you took Intersourcing and just – we’re averaging $9. So just take the $1.2 million, take $9, multiply it by the employees, gets $1.2, that’s what it is. So, if someone looks at that they’ll say that’s a very low number so if a lot of people chose it, it would be greater than that.

Franco Turrinelli – William Blair & Company, LLC

The other question I had for Mitch, I’m sorry I was trying to scribble the numbers but I think I had a miss. Could you walk me through again the comments you made that on a comparable basis adjusted operating margin is going to increase 500 basis points from this year to next year which I’m assuming that you’re saying that excluding license fees and Ceridian operating margin would have been approximately 1% this year. Am I hearing you correctly and could you kind of walk me through it again.

Mitchell K. Dauerman

What we did was we took the revenues, averaged the last few years, we backed out the Ceridian revenue per year, we backed out the license revenues per year, we then took the cost of revenues and backed out only those costs that would go away as a result of not selling license because some of our costs will stay with us no matter how we sell our products. Then, in the operating expense side we took the operating expenses down for the license commission because obviously we wouldn’t pay those if we didn’t have licenses.

So, when you net all those adjustments down, you would end up – if you did that for ’08 you’d end up with about a .9% operating margin and you would get to a 5.8% operating margin in 2009, roughly. So that would be your expansion of 500 basis points and if you looked at the incremental operating income that’s generated it’s going to be around $10 million which on the growth in revenues is about 28%. That neutralizes the effect over the last few years so you can see a trend of what we’ve been doing and you know, keeping in mind the leverage in the model is coming from one, we made investments in 2008 in R&D, in new products and we had the push out in the time to live. But, as we go in to 2009 and going forward we’re expecting operating expenses to grow at about 12% for both years.

So, the op ex line is going to cause leverage in the model and then as that recurring revenue begins to hit, the ARR begins to hit the recurring revenue line on a consistent basis there will be an acceleration in a sense for the gross margins of recurring probably the back half of ’09 in to 2010. Unless that whole thing starts to flatten out a little bit relative to the growth in recurring revenue. That’s how you end up with seeing the back half of ’09 have a stronger expansion in the operating margin.

If you take it out to 2010 and you can do some rough numbers just using a 25% annual growth rate, keeping the same time live which you know we’re doing everything we can to see if we can accelerate it but, you end up with about $250 million of revenues in 2010 and you do end up with 12% to 13% operating margin. I think Franco it’s the logic of the model and how the recurring revenue model works.

Operator

Your final question comes from Analyst for Tom Ernst – Deutsche Bank Securities.

Analyst for Tom Ernst – Deutsche Bank Securities

Just one housekeeping question, what’s the headcount for enterprise? And, what is the target rate in ’10 and ’11? And, how has that changed?

Mitchell K. Dauerman

Sales?

Analyst for Tom Ernst – Deutsche Bank Securities

Yes, enterprise sales?

Scott Sherr

We’re at 25 senior enterprise sales people and five client base sales people which are part of enterprise and that’s going to stay flat through ’12.

Operator

Mr. Sherr I’d like to turn the call back over to you for any closing or additional comments.

Scott Sherr

Thank you all for coming on the call. Thank you for your support and I wish you all the best.

Operator

This does conclude today’s conference. We thank you for your participation. Have a wonderful evening. You may now disconnect.

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