The Ultimate Software Group, Inc. Q1 2009 Earnings Call Transcript

The Ultimate Software Group, Inc. (ULTI)

Q1 2009 Earnings Call Transcript

April 28, 2009 5:00 pm ET

Executives

Mitchell Dauerman – EVP, CFO and Treasurer

Scott Scherr – Chairman, President and CEO

Analysts

Richard Baldry – Canaccord Adams

Michael Nemeroff – Wedbush

Terry Tillman – Raymond James

Steve Koenig – KeyBanc Capital Markets

Nathan Schneiderman – Roth Capital Partners

David Cohen – JP Morgan

Franco Turrinelli – William Blair

Ilya Grozovsky – Morgan Joseph

Brad Reback – Oppenheimer

Dan Cummins – Lime Rock

Bradley Whitt – Broadpoint AmTech

Mark Marcon – Robert W. Baird

Presentation

Operator

Welcome to Ultimate Software's First Quarter 2009 Financial Results Conference Call. Your presenters today will be Mr. Scott Sherr, Chief Executive Officer, Chairman and President, and Mitchell K. Dauerman, Executive Vice President and Chief Financial Officer. At this time, all participants are in listen-only mode. Today's conference is being recorded.

We will begin with comments from Mitchell Dauerman.

Mitchell Dauerman

Thank you, Jay. Good afternoon and thank your for your interest in Ultimate Software.

Before we begin, please be aware that we will be discussing our business outlook and will be making other forward-looking statements regarding our current expectations of future events and the future financial performance of the company. These forward-looking statements are based upon 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 publicly update or revise any forward-looking statements whether as a result of new information, future events or otherwise.

I'm going to begin by reviewing our financial results for the first quarter of 2009 and then, provide financial guidance for the second quarter. Unless otherwise noted, our discussion will be on a non-GAAP basis for all cost, gross margin, operating and net income, as well as EPS, when comparing 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 our financial information on a GAAP basis to that on a non-GAAP basis, attached to the press release published on our Web site.

Now turning to the first quarter, recurring revenues were $30.9 million and total revenues were $48.8 million for the quarter. Non-GAAP net income was $1.7 million or $0.07 per share. For Q1 our recurring revenues of $30.9 million came in towards the high end of the guidance of $30 to $31 million. Recurring revenues grew by 20.2% from the same period last year as reported.

Excluding the subscription revenue from the Ceridian agreement which seized after Q1 of 2008, our comparable recurring revenue growth rate for Q1 of 2009 was 27.4%. Our time for live periods for Intersourcing sales remained inline with our expectations. The attrition rate for our customers remained at a 3% annualized rate.

We have continued tracking the employee growth rate for our existing Intersourcing customer base, using a same-store sale type of financial metrics and found that the employee count of our existing customer base shrunk by 2.7% from the end of December 2008, through the close of March 2009. Keep in mind that due to our contractual arrangements a reduction in employee count does not necessarily result in a reduction in recurring revenues.

Services revenues in Q1 were $15.9 million, which was at the lower end of our guidance of $16 to $17 million. We continued to experience pressure on discretionary type sending from our customers for incremental implementation work and classroom and on-premise training.

Please note that Q1 includes approximately $1.8 million of revenue associated with producing W2s [ph] which has a high gross margin and occurs only in Q1 of each year. License revenues were $2 million for the quarter, inline with our guidance and down from $3.7 million last year.

Turning to cost of revenue and the gross margin side of our Q1 '09 results. Recurring revenue costs were a little lower than our expectation, partially due to timing of certain expenses, resulting in a 71.7% gross margin compared to a guidance of 69% to 70%.

Service cost and license cost were inline with our expectations, with gross margins slightly below our expectations. Total gross margins from all revenues sources, both in dollars and as a percentage of revenues, were better than our expectations as the revenue mix favored recurring revenues.

On the operating expense side, our total operating expenses were $24.9 million compared with guidance of $24.5 to $26 million. Sales and marketing and R&D were at the low end of the guidance, due to a combination of permanent savings from lower cost, such as travel and entertainment, and due to timing items, or expenses that did not occurred to (inaudible) this quarter as planned that are expected to be incurred before year-end. G&A was just slightly above our guidance.

Operating margins were 5.9% compared with our guidance of 4% driven by higher recurring revenue margins and lower than expected expenses.

Excluding the impact of the Ceridian revenue and higher license fees in Q1 of last year, the comparative operating margin for Q1 of '08 would have been a little north of 4%.

Our non-GAAP income tax rate was 42.9%, which was higher than expected and was the result of the relationship between our prominent tax differences and the non-GAAP income level.

We expect that the non-GAAP tax rate may stay at this level for the rest of year. Our cash income tax rate will remain in the low single digit as previously expected.

Turning to the balance sheet, total cash and investments in marketable securities were $24.5 million at the end of March. We generated $3.5 million in cash from operations for the quarter, inline with our expectations.

We invested $1.9 million in total capital expenditures during the quarter. We did not purchase any of our company's stock during the quarter.

Accounts receivable increased to $32 million from $29.9 million at the end of March of last year. DSOs were 60 days at the end of this March, compared to 63 days at March 31, 2008.

Deferred revenues were $61.3 million on March 31st, which was an increase of $9 million from March of last year.

As a reminder, deferred revenue in the first quarter reflects the seasonality in annual maintenance billings. It is typical in the first quarter that maintenance revenues recognized in the income statement really see the annual maintenance billings recorded as deferred revenue on the balance sheet.

In addition, deferred revenues also reflect a change in contractual implementation service.

As we turn to guidance, we would like to point out that we have decided to discontinue provided guidance with respect to annual recurring revenues or ARR.

Based on the companies belief that overtime this metric has become less meaningful as a forecasting tool, primarily resulting from the addition of our workplace offering in various new products that have different deployment cycles and prices.

In addition, we have found that both our competitors and the investment community have misinterpreted certain data points we have provided. Instead, the company will provide quarterly guidance on key financial metrics related to its financial statement such as recurring revenues, total revenues and operating margins.

The practice of providing quarterly financial guidance was first adopted by Ultimate in its fourth quarter of 2008.

So now turning to the expectations for Q2, we expect recurring revenues to be between $32 million and $33 million. We expect economic pressures to continue impacting our service revenues.

And as discussed at year-end, we intend to start selling on private [ph] perpetual licenses this quarter.

We expect total revenue should be between $47 million and $48 million. Operating margins should be approximately 3%.

Stock-based compensation and amortization of intangibles should be approximately $3 million and diluted weighted average share count should be about 25.7 million shares.

While recognizing the uncertainty in today's economic environment, we are not changing our guidance for the full year. However, we know that the economic pressures on service revenues continued into Q1 and it's only prudent to expect that similar pressures will continue throughout the rest of the year.

We believe we will be able to offset any potential reductions on the revenue side by managing our total expenses accordingly, which would therefore allow us to achieve our 2009 operating margin target as previously provided for the full year.

Turning to our upcoming conference schedule, on May 20th we will be in Boston at the JP Morgan Technology Conference. And on June 11th, we will be at William Blair's 29th Annual Growth Stock Conference in Chicago.

If you're available at those conferences to meet, please let us know. And now, I'd like to turn the call over to Scott.

Scott Scherr

Thanks, Mitch. Thank you to everyone for participating in our call this evening. As Mitch said, our first quarter '09 recurring revenues were nearly $31 million, up 20% compared with the first quarter of last year.

And our total revenues were $49 million, up 12%. And our customer retention rate for our recurring revenue base remains at an industry high of 97%.

Looking it fail, 65% of our new enterprise customers in the first quarter came from companies with more than 3,000 employees, an indicator of our continuing success in the large company market.

Attached rates of our complementary product continues to be high with all our new customers. Some of our new SaaS enterprise customers were Safelite AutoGlass, Seliron [ph], the world's largest vehicle glass repair and replacement company with 8,000 employees, they signed on for core UltiPro recruitment, performance management, learning management, onboarding and salary planning and budgeting.

Heritage Valley Health System, a healthcare organization, with 4,000 employees selected recruitment performance management, learning management and onboarding, in addition to core UltiPro.

Public Storage, a New York stock exchange company, with 5,300 employees and more than 2,000 self storage locations signed up for onboarding, as well as, core UltiPro.

Lumis [ph] a NASDAQ online and mall-based retailer with more than 4,000 employees also selected onboarding, in addition to core UltiPro.

Spartech Corporation, a manufacturer on a New York Stock Exchange with about 3,000 employees, selected recruitments and core UltiPro.

And last, P.F.Chang's, the large restaurant chains, with 30,000 employees signed up for recruitment, onboarding and salary planning and budgeting, in addition to the core UltiPro.

Some of our new SaaS workplace customers were Cardiovascular Institute of La Salle [ph] with 500 employees, selected UltiPro workplace, recruitment and performance management.

Fiorella's Jack Stack Barbecue, with 500 employees, selected performance management, in addition to the core solution. Picerne Military Housing Inc. with about 700 employees selected UltiPro workplace recruitment, performance management and salary planning and budgeting, and a Visiting Nurses Association with 670 employees signed on for recruitment, in addition to the core solution.

We continue to have the healthy and expanding pipeline. In Q1 '09, our marketing team reported the highest number of lease looking to purchase within 24 months or less in Ultimate's history. The second quarter forecast from our sales team is very positive and our activity is strong.

Our implementation team had a productive first quarter bringing 75 new customer live on our core UltiPro solutions.

Some of our new enterprise customers that went live were Google with more than 10,000 employees, Fujitsu with 6,000 in the United States and 1,800 in Canada, Great American Insurance with 6,000 employees, People's United Bank with 4,600 employees and NEC Corporation with more than 2,200 employees.

Some workplace customers that went live were Carolina Neurosurgery and Spine Associates with 230 employees, eClinicalWorks with 500 employees, Nova Biomedical with 650 employees, Online Resources with 630 employees and the World Racing Group with 275 employees.

In our services area, we obtained 100% uptime for both the servers and the network for our Intersourcing SaaS environment, a perfect quarter. And our overall growing 12 months retention rate for our existing, recurring revenue customers remained strong at 97%.

In closing, our business model for 2009 is based upon acquiring 100 new customers in the enterprise market and 300 new customers in the workplace market. At the same time, we are always looking to make our products and services better, that's what we've always done and what we'll continue to do.

Product and service excellence create customer satisfaction that fuels success with our business goal and we strive now the finest sale force in the industry to represent us in the market. We look forward to executing on our plans.

Thank you for your support over the years, it's greatly appreciated. Let's move to the Q&A.

Question-and-Answer-Session

Operator

(Operator instructions) We'll go first to Richard Baldry with Canaccord Adams.

Richard Baldry – Canaccord Adams

Thanks. Just hoping you could talk a little qualitatively maybe about, as you're not going to give the booking's number, so qualitatively about the portals, where you see your team has now, it's early in the year about tough. What do you think that's at or above or below your expectations? Maybe talk a little about the hiring and the number of quarter sales reps? I'm not sure if you can disclose this but a sort of discussion on the Google sales cycle, how competitive that was? What do you think your strengths where that got you over to the win on that? Thanks.

Scott Scherr

Well, on the sales side we're a 100% staffed in both, enterprise and workplace. We had a good first quarter and I have no reason to believe we're not going to achieve all our goals for the year as this is evidenced by (inaudible) change our annual guidance. I think Google was a takeaway from our number one competitor. And probably, it might have been a six months sales cycle I guess, but not 100% sure. They came down here, a lot of us went out there but obviously we're excited about getting it, they are a great customer. We have a great relationship as they let us use their name today. Did I answer the question?

Richard Baldry – Canaccord Adams

Yes. I think at the end of last quarter you said, there is about a million employees live on in resourcing, I wonder if can update that number?

Scott Scherr

The million was such a big mark for us. I don't know what the exact number is today Rich but obviously more than that.

Richard Baldry – Canaccord Adams

Alright, thanks.

Scott Scherr

Thank you.

Operator

And we'll go next to Michael Nemeroff with Wedbush.

Michael Nemeroff – Wedbush

Hey guys, thanks for taking my question. Did you achieve the 30% ARR growth in the quarter that you guided to last quarter?

Scott Scherr

I'm not talking about specific sales numbers, I could just tell you that the sales team is on track for the year and that's where we're going to.

Michael Nemeroff – Wedbush

So that the yesterday's dig, we're on track?

Scott Scherr

Whole team was on track for the year.

Michael Nemeroff – Wedbush

So they did make the ARR growth?

Scott Scherr

I didn't say that.

Michael Nemeroff – Wedbush

Okay. So the question I have Scott is that, last quarter in the press release says that bookings for the past indicator has helped the business in this quarter. It seems like it's an inappropriate metric to look at. What's the rationale for? And then you also mentioned an expansion in this prepared remarks that the Street and investors were getting some things wrong with respect to the ARR number. Could you just maybe flush that out and tell us why that is?

Scott Scherr

I think two things. One, I think from a competitive standpoint we have to get too much information. I'll call it our number one competitor, uses against us with misinformation about what we say on the earnings call. So, it's probably if you ask me what the rational was, probably 80% competitive. It's not going to give our attached rates anymore; not going to give how much business came from our place. And then not going to give how much of our sales team as that plan or not a plan to give our competitors something that they can use to misinform our prospects. And I get involved with enough prospects to see the stuff that they've put out. I'd say probably 20% or we have 20 analysts covering us. The difference between 1 and 20 is like you're talking about two different companies with all the information we gave. So we thought, hey, that's it. We'll give exactly what we're going to do every quarter in recurring revenue, in total revenue and operating margins. And then we'll give annual guidance all the time. So, if someone believes those numbers then they believe it. If they don't, then they don't, but at least its not open system coming up with a number through recurring revenue going forward. There are too many aspects of our recurring revenue number that people, obviously, are getting wrong there.

Michael Nemeroff – Wedbush

Okay. And Mitch, last quarter you had mentioned that you were modeling I think a minus 4% employee count at the existing customers. You mentioned that this quarter was minus 2.7%. Do you still feel confident that your 4% guidance number for the employee count reduction is going to be good for the year and then maybe update that if not?

Mitchell Dauerman

Yes, Mike, just to clarify and I tried to say this in the call, the 2.7% was an absolute number but it does not necessarily mean for every one of those that reduced, it reduced recurring revenue because of our contractual arrangements. The 1% per quarter or 4% for the year, it was all revenue reduction. I think we're holding with probably a little bit above 4%. But I think when you look at the range of our recurring revenue guidance, it's kind of wide enough that it takes into account that certain things could come in a little bit differently. So, hopefully that answers your question.

Michael Nemeroff – Wedbush

Okay. Thanks for taking my question.

Mitchell Dauerman

Sure. Thanks.

Operator

We'll go next to Terry Tillman with Raymond James.

Terry Tillman – Raymond James

Yes, thanks guys for taking my questions. First to mention in terms of the second quarter with the operating margin being lowered in maybe a lot of our expectations, were the OpEx numbers higher or gross margin? What do we think about that are big upticks Q-to-Q?

Mitchell Dauerman

From Q2-to-Q2?

Terry Tillman – Raymond James

1Q-to-2Q.

Mitchell Dauerman

Well, I think the differences we've mentioned was that we no longer intend to sell license software on premise license, so that's going to have a high margin. Secondly, on the services side revenues are going to go down. I tried to point out in the prepared comments, we had W2 revenues at $1.8 million, that's very high margin. And then as we look at our operating expenses, we know that some of the savings that occurred in Q1 against what we expected similar timings items and so, right now we think some of those items could be spent in Q2 and some of the items in Q1 were prominent. So, it could turn out some of our expectations in Q2, could be more permanent than timing. I think the biggest change is the change in license and the change in services.

Terry Tillman – Raymond James

Okay. And then, Scott, in terms of – in lieu of ARR numbers going forward, could you may be at least qualitatively talk about work place versus Intersourcing in 2Q in terms of how they did versus your expectations because one or the other stronger than expected or did one stand out more than the other?

Scott Scherr

The overall sales organization did well in Q1 and I'm not going to give numbers on either one of them (inaudible) what I expected.

Terry Tillman – Raymond James

Yes, I wasn’t asking for numbers, but in terms of – you did give numbers or targets for the year of a 100, Intersourcing in 300 workplace. Would you give us a report card at the end of the year on how you did versus those targets?

Scott Scherr

Yes.

Terry Tillman – Raymond James

You will. Okay. Thank you.

Scott Scherr

I believe both are on track.

Terry Tillman – Raymond James

Thank you.

Operator

We will take our next question from Steve Koenig with KeyBanc Capital Markets.

Steve Koenig – KeyBanc Capital Markets

Thanks a lot, can you hear me okay?

Scott Scherr

Yes, Steve.

Steve Koenig – KeyBanc Capital Markets

I wanted to ask you all, looking at deferred revenue, understand the Q1 seasonality, it does however looks like it was down more than usual this Q1, where it may have been kind of flat year ago was down this quarter. I am wondering if you can give any color behind that.

Mitchell Dauerman

Yes, Steve, I think if you – again, if you go back to the comments, we try to bring that up. You have the seasonality and maintenance, which drives that. But you also have in certain cases contracted implementation services. So, depending on what happens in the quarter, whether if there is more use of those services versus new contracts being signed, you can get some changes in that area. I mean the other things that happen within our deferred revenue is we do collect a one-time fee, which gets amortized and does not get obviously rebuild. So, you could have different periods when that drops off. And then just as a kind of reminder, we built three months of service, when we find a contract. So, you won’t necessarily see a huge impact from new bookings.

Steve Koenig – KeyBanc Capital Markets

So, Mitch, can I conclude then that's, the sales implementation projects, I guess, you had mentioned the – kind of the incremental implementation work it was that, that was a little weaker not necessarily implementation of new projects.

Mitchell Dauerman

I think you are saying that with respect to differed.

Steve Koenig – KeyBanc Capital Markets

Yes, with respect to –

Mitchell Dauerman

No, no, my point on the differed was that the – if there is a contractual arrangement in which the services are not time and materials but the contracted core in a different manner then they will flow through differed.

Steve Koenig – KeyBanc Capital Markets

Okay.

Mitchell Dauerman

You could have same clients one that the contractual arrangement its time and materials, just build as you go and you can have others that have different arrangements that from accounting perspective will get both through differed.

Steve Koenig – KeyBanc Capital Markets

Okay. So, and for that factor it was then a, kind of maybe a mix shift from fixed price to a little bit more T&M this quarter, is that what’s accounted for that factor?

Mitchell Dauerman

In essence, that’s what we are trying to say it.

Steve Koenig – KeyBanc Capital Markets

Okay. Thanks. I will get back in the queue.

Operator

And our next question comes from Nathan Schneiderman with Roth Capital Partners.

Nathan Schneiderman – Roth Capital Partners

Hi, thanks very much for taking my question. Scott, just wanted to ask one more question on this decision to no longer give new ARR. You did mentioned that, you thought the analyst community was confused over the issue, but I was a little confused on what you thought analysts were confused with?

Scott Scherr

I will just go by the 20 analysts and the numbers they have. When you take our – the information we have to give, we would have – which we have been given, was you have to give obviously what was enterprise, what was workplace and you have to have attached rates of our complementary product.

So, the time collide with all those things differ. I look at all the 20 and there is a huge differential and where our recurring revenue goes. I think, by giving exactly what we’ve done and exactly what we believe we are going to do next quarter and keep doing that and then keep giving annual recurring revenue and obviously, you need to sell to keep pumping up the recurring revenue, and we are giving a pure numbers that we believe. Again, it’s about 20% decision was based on the analysts, not 80% was based on competitive rate.

Nathan Schneiderman – Roth Capital Partners

But you felt like the confusion was how to model the recurring revenue or what the meaning of the new ARR was?

Scott Scherr

How to model the recurring revenues?

Mitchell Dauerman

Okay, there are too many components to it. You need to saturate, you need the different products, you need to know how much is workplace. And just not going to keep giving our competitors all that information, quarter-to-quarter, because it comes back at us in all kinds of different ways so I do it. We’ve decided what could be better than this given the actual numbers. We are giving you exactly what our model shows. For Q2, and for the year, the year has not changed.

Nathan Schneiderman – Roth Capital Partners

It seems like new ARR was a pretty helpful at least leading indicator of how the business was doing. Are there other leading indicators you would point us to as an alternative?

Scott Scherr

I gave you enough – in the quarter. And I typically gave you sales that we got in the quarter. I specifically gave multiple bandwidth large accounts that went live in the quarter. I think that's a huge indicator and obviously our result is the biggest indicator.

Nathan Schneiderman – Roth Capital Partners

Okay.

Scott Scherr

And our guidance is the biggest indicator.

Nathan Schneiderman – Roth Capital Partners

Okay. Could you give us a number of – I'm not sure if you're providing this anymore, but are you able to give us the number of reps broken down into enterprise and workplace?

Scott Scherr

60 total reps, I'm not breaking them down. We're about 60 total quoted carrying reps right now.

Nathan Schneiderman – Roth Capital Partners

And then final question for Mitch, I was just curious on linearity for the quarter. DSOs came down and I wonder if that was a reflection of maybe a tough close in the quarter or anything you can say about month one, month two, month three in linearity? Thanks very much.

Mitchell Dauerman

Nat, we're not going to comment on linearity. But on DSOs, I think it's basically a function of lower license. When you go back to last year, typically a license is going to drive the DSO up, and also I think better collections.

Nathan Schneiderman – Roth Capital Partners

Thank you.

Operator

Our next question will come from David Cohen with JP Morgan

David Cohen – JP Morgan

Hi, thanks. There's been a lot of discussion among some of the other payroll providers about pricing. Could you talk a little bit about what you're hearing in the market in pricing from customers and your expectation for being able to push through your sort of regularly schedule price increases?

Scott Scherr

It's competitive. I think try and teach our people to sell value. We do sell value. We are inline with our – I think Mitch had mentioned on the services side. We are getting some pressure on the services side. I think on new business PPM, they are kind inline with what we think.

David Cohen – JP Morgan

So are you seeing existing customers come and say, hey, we understand we have a contract, but it seems tough for us right now, can you help us out with some price concession?

Scott Scherr

No, not overall. I mean, we always have, one or two all the time, and things like that, we always try and do the right thing. We have very good relationship with our customers. We have a 97% retention rate. We have a referenceable base, almost close to our customers to partnership with us. So I don't think there's anything out of the ordinary that's going on now than in the past.

David Cohen – JP Morgan

And if, I think it's after about two years, that's sort of normal price increases and there's not sort of one point in the year where price increases rolls through the whole customer base, is that right?

Scott Scherr

Dave, well they happen as those two years expire and then each year annually after that.

David Cohen – JP Morgan

Okay. And then in terms of the implementation cycle, I think I heard you say that, it's sort of been consistent change. So one, did I hear that right? And two, what's your expectation for being about just sort of work that back down somewhat towards where perhaps in the direction where it used to be?

Scott Scherr

Dave, I think, you did hear that correctly, they didn't remaining the same. But I think you and everyone else has heard us talk for the last, probably almost a year now that we are focused on doing what we can to manage this deployment cycle until we can take to make them shorter. There's a lot of focus on it. But I think we've also said before if they end up staying at this range that works as well too.

David Cohen – JP Morgan

Okay, great. And just last question, Mitch, just a housekeeping one. I know you mentioned the non-GAAP tax rate, what do you expect the GAAP tax rate, the book tax rate to be for the year?

Mitchell Dauerman

This will get a little bit complicated, so if your tax back expert you will understand it, because if you look at probably your models, anyone's models, the forecasted GAAP net income or net loss is relatively close to zero. So as a result the tax rate as a percentage won't make any sense, because of our permanent differences and certain states in which there is a tax irrespective of your taxable loss or income. We're probably thinking we'll probably have about a $200,000 GAAP tax expense for the year.

David Cohen – JP Morgan

That's very helpful. Thank you.

Mitchell Dauerman

I'll give it you, but I can explain in more detail.

David Cohen – JP Morgan

No, I got it, thanks.

Scott Scherr

Okay. Thanks, David.

Operator

Our next question will come from Franco Turrinelli with William Blair.

Franco Turrinelli – William Blair

I'm assuming that's me. Just wanted to check you said a 100 new enterprise customers, 300 new workplace customers, is that for the full year or for the remaining nine months?

Scott Scherr

Full year.

Franco Turrinelli – William Blair

Okay. And then in answer to one of the other questions I think you said that you've given us a sales number for the quarter, but I'm not sure we actually have, unless I missed it.

Scott Scherr

I didn’t say that.

Franco Turrinelli – William Blair

Okay. I'm less interrupted what you said then. Can you give us a little bit more color on the pipeline you indicated that it was higher than it's ever been before or maybe I want to clarify exactly what you said there and maybe just little bit of insight into, why that might be?

Scott Scherr

I think as I mentioned in marketing we had the highest that we tracked, obviously, the reason we track our leads on all our campaigns, on who is looking within the next 24 months. And in Q1 it was the highest that has ever been in ultimate history. I think the pipeline is higher, but I think this was how we built our sales force; it should be higher all the time because we have more people on quarter happening all the time now. So the pipeline is higher than it's ever been. The important thing is that we're getting more leads in there. The seminars we're doing, we're getting more people coming for these seminars. The marketing we're doing, we're getting better responses. I think in good times and bad times people realize with HR that they needed it, and with HR Systems that recruit quality people and maintains the quality people in the organization.

Franco Turrinelli – William Blair

Just focusing on that number of leads, would you say that Ultimate is seeing more of the leads that are out there or do you think it's just an issue of there are more opportunity there? Do you feel I'm saying, I'm just trying to understand if you think that you've gotten better of the marketing or if there are employees in fact, a replacement cycle or a wave of some reasons?

Scott Scherr

I understand. I think 100% we're seeing more of the leads that are out there. I think we are far from a chipping point with Ultimate Software. I mean as amazing it is to you that some people that we see they say who is Ultimate Software? But that happened. So I think we are seeing more people out there. I think it's a natural evolution of a company that's successful, just more people, more heads of HR leave a company go to another company, and more people do know our name. I think as long as we keep the product strong, the service strong and good relationship, referenceable client base, we're going to continue to keep getting more and more looking at us. And when people do look at us, we have a very good opportunity to close that business.

Franco Turrinelli – William Blair

Okay. Two more questions if I may. The first is, you're periodically given us a little bit of annual presentation. You have a chart that kind of show us about who you've been taking business away from? And I think one of the things in 2008 was that we saw a little bit of a pickup in you taking business away from existing in-house software installation. Has there been any kind of change in the competitive environment or change in who it is that's choosing Ultimate last year result?

Scott Scherr

I don't think so. We have our favorite number one competitor and I'm looking right now frankly at Q1 compared for last year and I think it's pretty similar.

Franco Turrinelli – William Blair

Pretty similar. Okay, one last thing and I don't want to read anything into sort of one quarters, the cycle of new customers, but we certainly picked out a few restaurants in there. Again in 2008, we've seen a pretty significant pickup in interest in the healthcare business. It's this kind of a new vertical that you feel you're getting some incremental traction from or do you think this is just kind of a one-off in this quarter?

Scott Scherr

I think we've always been good with restaurant. (inaudible) such a great restaurant, such a great prospect, such a great new client just wanted to say it. So we believe in with restaurant, something get go always.

Franco Turrinelli – William Blair

Thanks so much.

Scott Scherr

Thank you.

Operator

Our next question will come from Ilya Grozovsky with Morgan Joseph.

Ilya Grozovsky – Morgan Joseph

Hi, guys. I had a just quick question on the balance sheet. You guys had an uptick in the client fund obligations; can you just go into that and what's going on there?

Scott Scherr

Sure, Ilya. As you know, beginning Q2 of last year, we went into the tax filing business so we are capturing clients' funds. So as that business has grown those funds would grow as well. The growth both from absolute number of customers and also the cycles of their payrolls. So depending on when the quarter ended the amount of dollars we would be holding versus having remitted to the jurisdiction.

Ilya Grozovsky – Morgan Joseph

Okay. Thank you.

Operator

Our next question comes from Brad Reback with Oppenheimer.

Brad Reback – Oppenheimer

Hey guys, how are you?

Mitchell Dauerman

Good, thanks, Brad.

Brad Reback – Oppenheimer

Hey Mitch, at last call you had talked about your 2010 goals of a 40% contribution margin and then as well as your 2012 goal of $400 million. Is there any reason for us to think that you separated from those because you haven't repeated them here?

Mitchell Dauerman

No, no reason to think we have changed anything.

Brad Reback – Oppenheimer

Okay. And guys, have you altered your hiring plans at all through 2009 given the rough start to the year for everybody?

Scott Scherr

No, I think we had a plan employed. I think some people chosen at a higher quickly but we have not changed our plan for the year.

Brad Reback – Oppenheimer

I am just going to ask what's your expectation for the total headcount increases.

Scott Scherr

It was about 50 heads for this year. I mentioned I think crash year was the real year. We hired well over 200 heads last year. But this year the plan going in was about 50 new heads – growth oriented in the sale.

Brad Reback – Oppenheimer

Got it. And last question, just if you could remind us, what’s the typical seasonality over the course of the year it looks like for the sales side of the business. How much is sort of waited to the back half, versus the front half, if there is any difference?

Mitchell Dauerman

There is a difference, Q4 is always a highest, Q2 and Q3 could go either way, so it's four; two and three could go either way, and then one is the least and that’s how we skew our quarters.

Brad Reback – Oppenheimer

Any percentages you could roughly wrap around that, is it 60% in the back half versus 40% in the first half or?

Mitchell Dauerman

Yes, I could you give that, so its 42.5 that’s first half, 57.5 second half.

Brad Reback – Oppenheimer

Excellent, thanks a lot.

Operator

Our next question will come from Dan Cummins with Lime Rock.

Dan Cummins – Lime Rock

Thanks. Yes. I was going to ask the same question, but around the idea of our customer adds, our first half and second half of the year, if you could kind of give us how that seasonality work. And I was curious, if you have in mind the targeted quarter when you guys would be back within spitting distance of a double-digit operating margin. Thanks.

Mitchell Dauerman

In the quarter is four and the other thing, it goes with our quarter, obviously it could go out, quarters, but it goes with, 42.5 to 57.5, I mean its.

Dan Cummins – Lime Rock

Okay.

Mitchell Dauerman

Did I answer that?

Dan Cummins – Lime Rock

Guys, could I ask one more. Just so, tracking out the guidance on the ARR, which previously of around 30%, that would imply, if you made the recurring revenue number this year, that you might be again, a mid-20 revenue growers in 2010. I think you still have in minds that level of performance not withstanding large numbers. Is that – still in that range?

Mitchell Dauerman

Yes, I think that was there. As the question about, what we said about 2010 and ’12 before, nothing going to change our view on that. So that be…

Dan Cummins – Lime Rock

Okay. Thank you.

Scott Scherr

Sure.

Operator

And our next question comes from the Steve Koenig with KeyBanc Capital Markets.

Steve Koenig – KeyBanc Capital Markets

Thanks for getting me in again. Scott, I’m curious to know, when you look at closed rates and deal cycles and market demands. Do you sense any sort improvement in March and April, potentially over kind of January and February, or is it just too difficult to get that granular?

Scott Scherr

It is always, in our business, I mean January is a slow rate month, we are in payroll business, and in payroll January doing W2, it’s bigger than a payroll is your W2. So, it always does, January is the weakest month and you got the February and then typically you have the really good March, which we did. And then you go from there.

Steve Koenig – KeyBanc Capital Markets

And Scott, do you see that there being any change from prior years in terms of the kind of to be there or other rate of improvements? Is software companies by and large had pretty tough Q1, and we’re just kind of get a sense of kind of is the market dying or is that beyond just normal seasonality?

Scott Scherr

Yes, I think, I know our name is Ultimate Software, but I hardly consider as a software company anymore. We just don't deal with that anymore. Our Q1 is what we expected and I think no reason to believe that, the rest of the year is going to be what we expect. A very strong sales team that is going to execute that I believe 100% execute, that has executed, did execute and will continue to execute. Thus our guidance for what we believe the recurring revenues to be in Q2 and our annual guidance. And after Q3, we will give 2010 which we always do, and I think its going to be inline with what we thought.

Steve Koenig – KeyBanc Capital Markets

Okay. That's very helpful. One last question if I may. You've explained your reasons for not giving ARR. I understand those reasons. I'm curious to know why now, why this quarter are we not seeing it?

Scott Scherr

I think we've been talking about it. Me and Mitch have been talking about it for a lot of quarters. I think it's just, as we go more and more there is multiple people on this call from our competition. And I've been involved in more and more deals and as you see like everything about our attached rates, our sales force and see the misinformation getting larger and larger and whenever we did it, you would ask that question. So, just to say its okay, I never was a proponent of quarterly guidance. Even though for know we've started in giving quarterly guidance and annual guidance every quarter and then it's just a matter you believe its going to happen or not believe its going to happen, Obviously, you need the result in sales to create the recurring revenue growth in your model. Now follows it and I think as somebody trusted us for a while, we were one of the last people who gave ARR, (inaudible)

Steve Koenig – KeyBanc Capital Markets

Okay. Well I appreciate the response.

Scott Scherr

Oh sure.

Steve Koenig – KeyBanc Capital Markets

Thanks a lot.

Operator

Our next question will come from Bradley with Broadpoint AmTech.

Bradley Whitt – Broadpoint AmTech

Hey, guys. Thanks for taking my questions. Just curious Mitch, as when you do your internal model, how are you converting your ARR with the enterprise versus workplace, are you still taking a year out before the enterprise ARR converted to revenue?

Mitchell Dauerman

Well, we go through many models, but I think that my guess is the same as just Scott was talking about, why we're not going to give the ARR. There are too many different components that come into play. We run different models, and you'd have to get into every products that's sold and you have different ways of anticipating, what product are going to be sold and to what size customers and in which whether it's enterprise or workplace. So, as I said before, our deployment cycle hasn't changed. So that maybe a way of saying, in concept what we've been doing before is the same way of how we fill the model. But we do a number of models, but there is no exact point that you're going to get to.

Bradley Whitt – Broadpoint AmTech

Okay. And just curious Scott if you're seeing any additional discounting and anything unusual on the competitive firm, we're hearing about some of your competitors offering free implementation services, six months free service, that kind of thing. Are you seeing anything unusual out there from a competitive standpoint?

Scott Scherr

No, I think that we've been seeing that since the start of the Ultimate. But I think that's just something that we've seen and we have a very good sales force. We sell value; we sell direct to our client base. We sell long-term and I think that's what we've been doing. What you're saying you've seen we've always seen.

Bradley Whitt – Broadpoint AmTech

Okay, great. So any change?

Scott Scherr

I didn't have to put more people on off. There is more misinformation going out there but nothing we can handle.

Operator

We'll take one more question from Mark Marcon with R. W. Baird.

Mark Marcon – Robert W. Baird

Good afternoon. You've obviously seen more clients and you're getting to be better known to the economic environment at the same time it’s the worst that's been a long time. Are you seeing any impact with regards to the sales cycles? Just how long it takes them to make a decision?

Scott Scherr

No, I think we regret though you changed our people to find the pain. You find the pain and then slaughter the pain and obviously, try and get as many people in the pipe as you can, you're trying to create a big funnel and then you try and close what's in the funnel quarter-to-quarter, nothing has changed.

Mark Marcon – Robert W. Baird

Okay.

Scott Scherr

I think what I said we're seeing more people interested in us than we've ever seen. So that holds well for us because we see more people in the funnel and if we keep doing our job, we keep making the product stronger. If we keep our name sentiment retention rates, if we keep a record for those client base we're just going to get more business.

Mark Marcon – Robert W. Baird

Great. And can you talk a little bit about how you would expect sales in R&D expenses to trend as the quarters unfold? So any big sales factory?

Scott Scherr

No, I think marking the operating expenses. Here is a secret example, in Q2, sales and marketing expense will be lower because we do our annual club and national meeting in Q1 so there is some hard dollar expenses there that won't recur.

In R&D, there were some training in some consulting services that they are going to purchase in the second quarter versus the first. You get a little bit of that going on. Otherwise it's probably somewhere flattish for the balance of the year.

Mark Marcon – Robert W. Baird

Okay, great. Thank you very much.

Scott Scherr

Mark, thank you. Nice talking to you.

Operator

I'd like to turn the call back over to Mr. Sherr for any additional or closing remarks.

Scott Scherr

I just want to thank everyone for being on the call. Obviously, me and Mitch would be speaking to all of you, as we always do. Take care, everyone.

Operator

That does conclude today's conference. We thank you for your participation.

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