Ultimate Software Group Q4 2009 Earnings Call Transcript

Feb. 9.10 | About: Ultimate Software (ULTI)

Ultimate Software Group

Q4 2009 Earnings Call

February 9, 2010 5:00 pm ET

Executives

Mitchell Dauerman – Executive Vice President, Chief Financial Officer

Schott Scherr – Founder, Chairman, Chief Executive Officer

Analysts

Richard Davis – Needham & Company

Laura Lederman – William Blair

Michael Nemeroff – Wedbush Securities

Richard Baldry – Canaccord Adams

Nathan Schneiderman – Roth Capital Partners

David Cohen – J.P. Morgan

Brad Reback – Oppenheimer

Mark Murphy – Piper Jaffray

Raghavan Sarathy – Dougherty & Company

Ilya Grozovsky – Morgan Joseph

Roy Moore – YX Funds

Bradley Whitt – Broadpoint Capital

Operator

Welcome to Ultimate Software’s fourth quarter and year end financial results for 2009 conference call. (Operator Instructions) Your presenters today will be Mr. Scott Scherr, Chief Executive Officer, President and Founder of Ultimate Software and Mitchell K. Dauerman, Executive Vice President and Chief Financial Officer.

We will begin with comments from Mitchell Dauerman.

Mitchell Dauerman

Good afternoon and thank you 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, our future events and the future financial performance of the company.

These forward-looking statements are based upon information 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 year and the fourth quarter of 2009 and then I’ll provide financial guidance for 2010. Unless otherwise noted, my discussion will be on a non-GAAP basis for all costs, gross margins, 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 comp. Please refer to the reconciliation of our financial information on a GAAP basis to that on a non GAAP basis included in the press release published on our website.

For the year, recurring revenues grew by 25% to $133.4 million. Total revenues grew by 10% to $196.6 million. Recurring revenues as a percentage of total revenues increased to 68% from 60% last year.

Total gross margin expanded by 400 basis points to 56.3%. We managed our operating expense growth to 10% over 2008. Operating and pre tax net income were $12.9 million or $0.49 per diluted share and the operating margin for 2009 was 6.5%.

Non-GAAP net income after tax was $7.6 million or $0.29 per share. Share count for the year decreased by 100,000 shares to a weighted average of 26.2 million shares for the year.

Another way to look at 2009 is to remove the revenues from perpetual licenses which we discontinued selling during 2009 as well as the small amount of non recurring revenue in Q1 in 2008 from a former business service provider. On this comparative basis, total revenues grew by over 16% and the incremental operating margin expanded by 39%.

For the fourth quarter of 2009 we reported total revenues of $52.3 million and recurring revenues of $35.7 million. Non-GAAP net income for the fourth quarter 2009 was $2.6 million or $0.10 per diluted share and GAAP net income was $100,000.

For Q4 our recurring revenues were $35.7 million representing a 24% increase over the same quarter in 2008. The recurring revenue gross margin of 71.2% was in line with our expectations. The recurring revenue gross margin of $25.5 million exceeded for the first time our total operating expenses which were $24.4 million.

Our time to live period for core UltiPro remained in line with our expectations while we continued to see the push out of starting date on some of our complimentary products. The annualized retention rate was 97% for our recurring revenue customer base and our recurring revenues were impacted as well by changes in employment.

During the last year we had disclosed the same store metrics. However, as we look back at the year, it’s clear that this metric is not truly meaningful in terms of estimating the impact on recurring revenues.

There are several other factors that impact recurring revenues on a month to month basis including price increases, and seasonality to name a few. For this reason, we are discontinuing disclosure of this metric. However, for purposes of our quarterly and annual guidance, we do consider all of these factors.

Service revenues for Q4 were $15.9 million which were more than our expectations due a conservative estimate of billable hours for the fourth quarter based on experience earlier in the year. The excess service revenue drove the total gross margin for the quarter to be slightly above our expectations.

License revenues were $600,000 for the quarter. There were not new perpetual license sales in Q4. However, there were purchases of licenses for complimentary products from existing license based clients.

Our total gross margin rate for the quarter was 55.1%. Our operating expenses of $24.4 million and our operating margin of 8.5% were in line with our expectations.

Our non-GAAP income tax rate for the quarter was 442.1% bringing the full year rate to 41.4%. Our cash income taxes were nominal for 2009.

Turning to the balance and investments in marketable securities were $33.2 million at December 31. For the quarter, we generated $7.3 million from cash from operations. We invested $1.8 million in total capital expenditures and free cash flow was $5.5 million or $0.21 per diluted share.

For the year, cash from operations was $23.5 million and capital expenditures were $7.1 million. Free cash flow was $16.3 million or $0.61 per diluted share.

As part of our stock repurchase program, we used $5 million in the quarter to acquire 188,600 shares of our common stock. We have 1.014,575 shares authorized and available for repurchase as of today.

Accounts receivable increased to $38.5 million from $38.3 million at the end of last year. DSO’s were 68 days at the end of December 2009 compared to 71 days at the end of 2008.

Deferred revenues were $68.6 million on December 31 compared to $63.5 million a year ago. As a reminder, deferred revenues reflect the change in contractual implementation services which tend to fluctuate from one period to the next.

I also want to point out two changes which impacted our deferred revenue and our accounts receivable balance at year end. First, we implemented changes in our billing processes to make our invoicing more customer friendly. This impacted the timing of when we billed contractual minimums and the fees relating to actual employment counts in excess of contractual minimums.

In short, during Q4, we began to bill only the minimum in advance of the quarter. We moved the billing for the PEMP fees representing the excess employee counts over the contractual minimums from quarterly in advance to quarterly in arrears.

Secondly, in response to competitive pressures, we have modified the timing of payment typically due at the execution of our inner sourcing agreements. We have begun to defer the billing and collection of the initial three month subscription payment until closer to when the client goes live but still in advance of going live.

Neither of these changes impacted reported recurring revenues. However, both of these changes had the impact of reducing A/R and deferred revenues and will make it more difficult to compare A/R and deferred revenue trends on a year over year and a sequential quarter basis until we anniversary this change next year.

We made these changes now in light of our continued strong free cash flows as well as for business reasons.

Now turning to 2010 guidance, for the year we expect recurring revenues to grow by approximately 27% over 2009 and should represent 73% of total revenues. We have over 90% visibility into the 2010 recurring revenue target.

We expect total revenues to grow by approximately 18%. We expect license revenues to be about $1.4 million from existing customers either from growth or complimentary products.

As we’ve discussed in the past, we expect gross margin and recurring revenues to expand annually by about 100 basis points. We expect services gross margins to range between 15% and 18%.

Operating margins of approximately 10% should be produced for 2010. Excluding the impact of license revenues, this represents an expansion of our operating margins by nearly 500 basis points.

Our non-GAAP tax rate for 2010 should be between 41% and 42%. We expect cash taxes to be around $.5 million and diluted weighted average shares should be under 27 million.

We expect that CapEx will be approximately $12 million, depreciation and amortization to be about $13 million and free cash flow to be in the range of pre tax non-GAAP operating income. We expect stock based comp and the amortization of acquired intangibles to be between $13.5 million and $14 million.

For the first quarter of 2010 we expect recurring revenues to be approximately $39 million and total revenues to be approximately $55 million.

Looking at our costs from a sequential basis, Q1 of 2010 versus Q4 of 2009 will have higher costs. This is the usual pattern each year and it’s most due to employment related expenses particularly higher benefits typical at the beginning of each year when compared with the fourth quarter of the preceding year.

We expect operating margins for the first quarter to be approximately 6%.

Turning to our upcoming conference schedule during the next quarter on February 24, I’ll be at the RW Baird 2010 Business Solutions Conference in Boston. On March 8 I’ll be in Orlando at the Raymond James 31st Annual Institutional Investors Conference and in New York on March 10 at the Wedbush Securities 8th Annual Management Access Conference.

Finally, I’ll be in Dana Point, California at the Roth Capital O.C. Growth Conference on March 15. If you’re available at those conferences to meet, please let me know.

And now I’ll turn the call over to Scott.

Scott Scherr

Thank you to everyone participating on our call this evening. 2009 was a successful year for Ultimate. As Mitch said, our critically important recurring revenues were up 25% over 2008 to $133.4 million and our total revenues were up 10% over those in 2008 to $196.6 million. We also attained our 2009 operating income plan.

The fourth quarter was a strong close to the 2009 year. We achieved a goal that’s been in our vision for years, to have to recurring revenue gross margin cover all of our operating expenses, and we achieved record recurring revenues of nearly $36 million for the quarter, up 24% over 2008’s fourth quarter.

The enterprise team finished 2009 with record annual attach rates. Time in attendance was 34%, recruitment 60%, performance management 50% and in its first full year, on-boarding came in at 43%.

Looking at some of our new enterprise customers in the fourth quarter, Acon Group, the largest publicly traded construction and infrastructure development company in Canada with 2,000 employees signed up for our core UltiPro solution and time in attendance.

Ambion, a public company and leading provider of health care solutions with 2,000 employee’s selected recruitment, on-boarding, performance management, learning management, salary planning and budgeting, time in attendance and paycheck modeling in addition to UltiPro.

[Folkwood] worldwide, the leading provider of temporary housing globally with 4,000 locations and 1,400 employees signed up for core UltiPro HR and payroll and UltiPro time in attendance.

McFarlane Clinic, central Iowa’s largest physician owned multi-specialty clinic with 1,050 employees signed up for on-boarding, performance management, salary planning and budgeting, paycheck modeling and employee relations in addition to UltiPro.

Subway world headquarters selected recruitment on-boarding, time in attendance and performance management as well as core UltiPro solutions.

On selecting UltiPro, the business process analyst for Subway world headquarters Darren Oliver said, “UltiPro is a complete solution we found that the only one that can meet all of our needs. During our evaluation we identified 26 manual processes that can be automated out of the box. We’re also very excited to unify talent management, HR and payroll across our company with UltiPro.”

In 2009 we had zero turnover on our enterprise team and we entered the 2010 year with 30 full quota carriers, the team of experienced, long tenured and well positioned with many customer references to attain their 2010 goals.

The Workplace team continued its rapid growth pace in 2009 with a 58% increase in number of units sold over 2008. Workplace attach rates continue to be strong. In the fourth quarter, benefits enrollment was 77%, time management 69% and both recruitment and performance management were 62%.

Looking at some of the new Workplace customers in Q4, the Center of Creative Leadership with 400 employees chose performance benefits enrollment, performance management and time management along with core Workplace solution.

The Cashman Equipment company, a caterpillar equipment dealer with 575 employees signed up for recruitment, benefits enrollment, performance management and salary planning and budgeting in addition to core Workplace.

Ryan International Airlines with 510 employees selected recruitment, benefits enrollment, performance management, time management, salary planning and budgeting as well as the core solution.

And the SM Corporation, an environment and remediation services company with 550 employees selected recruitment, benefits enrollment, performance management, salary planning and budgeting in addition to our core Workplace solution.

We enter 2010 with 31 full Workplace quota carriers, a 50% increase of 2009 and a 97% increase over 2008. We have successfully built a team that covers the country in two short years. For 2010 we have expanded the parameters of the Workplace market increasing the top end of the company size from 700 employees to 1,000 employees and making the new enterprise target company size 1,000 employees and larger.

We expect this plan to be strategically effective for us as it allows Workplace to penetrate the upper end of the small business market.

In January, I attended the annual meeting of the Enterprise and Workplace teams. Our primary company goal over the last couple of years has been and is going forward to grow our recurring revenues by greater than 25% per year. They are the driving force behind our achievement of that goal and they are confident about continuing that success.

Their pipelines and their expanding market numbers give them reason for confidence. In the fourth quarter, we had the highest number ever expanding market in the quarter who said they are looking to buy a new human resource management solution. It was a record number in both our Enterprise and Workplace markets.

We also had the highest number ever of registrants for a single webcast in the fourth quarter, 2,165. For the 2009 year, we had a 56% increase in looking to buy responders in our Enterprise market and a 73% increase in the Workplace market, both compared with 2008.

In our Professional Services market we had a 3% for all four quarters of 2009. We ended 2009 with 989 associates, a net of 60 new associates representing 6.5% growth for the year. Our associates have made product and services excellence our hallmark. Their combination of experience, commitment and compassion has given Ultimate the ability to deliver our customers services unmatched in the market today.

I want to thank everyone at Ultimate for the honors they have brought us in 2009. First, Ultimate was honored again for the second consecutive year in 2009 to be named the number one Best Medium Sized company to work for in America by the Great Place to Work Institute, the same research and management consultant team that produces Fortunes 100 Best Companies to Work for lists for large companies.

Ultimate is the only organization to receive the number one position twice in this category. We are very proud of this award as it validates the power of our culture of trust at Ultimate.

Next, our two product awards. Ultimate won first place in the People’s Choice TV competition for favorite new SAS products sponsored by the American Business Awards. Other companies competing in the new best new SAS solution category were salesforce.com, Cisco Webex, Citrix Online, NetSuite and People Click. The nationwide was open to the public.

Ultimate was also named the winner of Inc. Strategies best of SAS showplace awards. These awards are presented by Inc. Strategies to bring greater attention to software and service and cloud computing companies that product tangible business benefits.

Last, in the service category, Ultimate’s customer support center was awarded SEP certification for best practices for the eleventh consecutive year. The SEP standards represents a global standard for service quality and are used by leading technology companies worldwide.

This is a pivotal time for Ultimate. Over the last four years we grew from 512 associates to 989, a net of 477 associates, representing growth of 93%. During the same four years, our most important metric, our recurring revenue grew by 165%. In the last four years, we have transformed UltiPro from a traditional payroll and HR software product into the industry leading solution for human capital management.

We added sophisticated talent management feature sets including recruitment, on-boarding, performance management, salary planning and budgeting for compensation management, employee relations for career for succession planning, time in attendance and tax filing.

We also perfected our software services delivery model, developed and delivered a Canadian UltiPro solution, migrated to Microsoft’s technology. During the same time period, we created our UltiPro Workplace solution for the small business market, put together an experienced and energetic well coached Workplace sales team which more than doubled the size of our sales force and made substantial progress in developing that market.

In 2010 Ultimate is moving into a new era of business strength and are approaching the tipping point on our journey. We achieved our long time goal to have recurring revenue gross margins cover our operating expenses in the fourth quarter of 2009 for the first time.

We have a long tenured enterprise sales team with a proven track record of success for the 1,000 employee and larger market and we have a very talented, aggressive Workplace for the 200 to 1,000 employee market.

We have won many third party awards for our culture product and service excellence. We have the leading human capital management product set in the industry today. Most important, our customer retention rate has remained consistent at 97% for 2009 and customer references continue to be plentiful.

We are excited about 2010 and we are equally excited about our future beyond that. We are now set to leverage our achievements and execute 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 Richard Davis – Needham & Company.

Richard Davis – Needham & Company

You’re getting a lot of success in you mid market effort which has done quite well. The question is when you’re hiring people and things like that, from where are you getting those people. Are they experienced in that market? Do you get them from whomever, but just talk about that because as you grow that, that’s obviously going to be an important part of your efforts.

Scott Scherr

We get them from our competition. That’s where we get them. We look for the best of the best in every area of the company that we hire. We pride ourselves on culture, product and service, and recruiting hasn’t been a problem for us and I don’t see it being a problem going forward.

Operator

Your next question comes from Laura Lederman – William Blair.

Laura Lederman – William Blair

I wanted to follow up on Richard’s question of not where you get employees but where you get the customers. How much are from service bureaus versus the software companies and give us a sense of that split in terms of service bureaus like ADP and Paychecks. And also can you quantify the impact on deferred pay and also A/R from the changes you made to the two changes to billing?

Scott Scherr

In the year 2009 in Enterprise we got 48% of our business from ADP, 18% from Ceridian, 9% from EPS’s and then other was 25%. That’s we had one or deals from somebody else.

In Workplace we had 66% of our deals from ADP, 7% from Paychecks, 7% from Ceridian and 20% from other.

Mitchell Dauerman

On the other question in deferred I would say the impact of going to billing in front to billing in arrears for the access was probably $2 million in terms of the deferred and the A/R. And then the deferral of the payment terms pushing them out might be another $1 million or so.

Operator

Your next question comes from Michael Nemeroff – Wedbush Securities.

Michael Nemeroff – Wedbush Securities

Has there been and degradation in the environment in the selling environment? I just want to understand why you’ve tightened up the guidance range towards the lower end on the top line and the recurring revenue growth as well as on the margin.

Mitchell Dauerman

I think it’s just we go to a range it might be easier for us. It might be considered by some. We gave $0.26 to $0.29 so the mid point was $0.275 so we said $0.27 on recurring. I didn’t see it like that, just trying to make it simple.

Michael Nemeroff – Wedbush Securities

Does the guidance assume any improvement in the labor markets and in higher end throughout the year or is it pretty much at the same level as you saw it entering the year?

Scott Scherr

In terms of all those factors that affect the employment counts, there are a number of variables. We’re assuming a slight decrease. I don’t think it will be as bad as it was this year.

Michael Nemeroff – Wedbush Securities

So your guidance actually assumes a slight decrease in the number of heads at your customers?

Scott Scherr

Yes, and that’s consistent with what we did when we gave our preliminary guidance at the end of Q3, but we obviously adjusted it to where the base ended at the end of Q4.

Michael Nemeroff – Wedbush Securities

If you would just remind us of your long term revenue and margin goals that would be helpful.

Scott Scherr

I think my long term is we’re shooting out for 2012 to be 20% and then hit the 400 in ’13 and get to the 25% operating margins in ’13.

Operator

Your next question comes from Richard Baldry – Canaccord Adams.

Richard Baldry – Canaccord Adams

The funds held line for clients stepped up pretty sharply in the quarter. Can you talk about whether that’s just a timing issue or how you started to see more enterprise customers coming into that line.

Mitchell Dauerman

Funds held customer comes from our tax filing business. It has progressed very well. It is a point in time as you know that it’s going to depend on when the payroll taxes are due to the jurisdictions, but I can tell you that when we looked at average type of float balances they are growing rapidly with the growth in the business.

We are have been adding some new enterprise customers to that base.

Richard Baldry – Canaccord Adams

Maybe not necessarily qualitatively could you talk about the per employee per month trends, where you’re at, where you think that is as a capacity versus penetration in your install base and where you think that can go in ’10 and forward?

Mitchell Dauerman

I gave you tax rates. The tax rates have grown and they continue to grow as we move forward. I don’t have the exact numbers of where we are but what I can tell you is it is growing. We probably are up to 60% of the opportunity. If everybody bought everything we had, we do have a client base and that’s 30 enterprise people who are full quota. We have five of them, our client base sales representatives are constantly contacting our base for the marginal’s that weren’t sold at the time of sale. But it grows every quarter.

Operator

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

Nathan Schneiderman – Roth Capital Partners

I had a few questions related to the guidance. One was I was just curious on the reduction on the operating margin to the 10% versus the 10% to 12% on just a very slight change to the revenue expectation and can you talk us through that? What do think has happened there to push it more toward the lower end?

Mitchell Dauerman

I wouldn’t read too much into that. I think in Q3 which is obviously early on, we were in the preliminary stages of doing our budgets. We gave a range of 10% to 12%. We get to the end of the year, we’re tightening it up a little bit. So I wouldn’t read much into it.

A way to look at it is, look at the expansion on the operating margins, 500 basis points which I think is a fairly strong amount and I think as Scott said earlier, we’re trying to just move to a more reasonable point that people can expect and maybe it will turn out to be conservative.

Nathan Schneiderman – Roth Capital Partners

Related to that comment, you’ve had a number of quarters now where you’ve needed to trim guidance expectations versus the prior view. Do you feel like you’re at the point now where it’s pretty balanced? It could go either way up or down going forward or do you feel like it’s much more conservative now so deviations would most likely be an improvement rather than a reduction.

Mitchell Dauerman

No offense meant, but I don’t think we view each quarter as trimming. I think that most people have known us for a long time, they know we talk to you about what our plans are, where we’re going, the long term plans and this is just within the range. So if you or others view that as trimming it or not, I would say we see it differently. We try to give you what we see are upsides, downsides.

For example, in Q4 we did take a more conservative view on our service revenue hours, and they came in higher. But again, that’s not a driver of the business. We don’t want you to set your expectations that it’s going to be higher, but could it? Sure.

I think our approach is to try to give you a realistic view of where we’re going but clearly keeping the focus on where we’re going to be in the future and are we on that path. Scott went through what the goals are for 2012 and 2013.

Operator

Your next question comes from David Cohen – J.P. Morgan.

David Cohen – J.P. Morgan

It sounded like some of the changes around the A/R and the deferred and the billing, if I understand right it was driven partly by competitive pressures. Could you talk a little bit more about what those competitive pressures look like?

Scott Scherr

We lead with culture, product, service. Those are the three things we try to be good at, get better at. In a competitive environment a lot of times our competitors, their three things are fear, data and price.

Forever my sales people have been telling me that if we didn’t get the first three months upfront that would help. So we just got to the point where we said we’re in a good position now. The cash flow is good. It seems like a good place to spend our cash so just move it back, so we don’t need the first three months upfront and some other things around that, the cash that we get up front.

It’s just a business move. I didn’t do it for a long time because I didn’t think we were in a position to do it and shouldn’t do it and now I decided to do it.

David Cohen – J.P. Morgan

Have the competitors gotten more aggressive then over the last three months or six months?

Scott Scherr

When I started Ultimate in 1990 a competitor offered six months free if he didn’t get Ultimate software. So it’s never changed. It’s free upfront. It’s free on implementation and another six months free against us.

That’s never changed. Our sales people sell value. If you get in there, sell value. Sell why we’re different. If you can’t sell value, then you’re not going to get the business. We do have a better product. We think we have better service and we think that we’re going to better three years from now and five years from now, and that’s what we have to tell our prospects.

In the long run, we’re going to be less money in the long run than switching all the time. So it’s been going on forever.

David Cohen – J.P. Morgan

In the December, January into February as seen by ADT and Paychecks is seen by both as selling and retention. Does that dynamic affect Ulti or is that not really relevant.

Scott Scherr

Zero relevance. Not relevant at all. That’s not how we are.

Operator

Your next question comes from Brad Reback – Oppenheimer.

Brad Reback – Oppenheimer

Did you mention or talk about hiring plans for 2010?

Scott Scherr

No.

Brad Reback – Oppenheimer

Do you care to comment?

Scott Scherr

What’s the question?

Brad Reback – Oppenheimer

What are your hiring plans for 2010?

Scott Scherr

In our model it’s based on 90 new heads all related to growth.

Brad Reback – Oppenheimer

So basically all in the sales and marketing?

Scott Scherr

No, all related to growth, mostly operations. A lot in the Workplace for implementation for the units we’re getting and planning to get, customer support for all the units we’ve gotten, especially in Workplace infrastructure based on what went on. So probably 10% is sales and marketing of the 90.

Brad Reback – Oppenheimer

And with those roughly 10 people in sales and marketing, you’re very comfortable as you hire them over the course of the year you’ll be in a position to sustain current growth rates in 2011. There’s been obviously a few other companies out there in other aspects of the SAS world that have dramatically ramped up spending to the surprise of investors. So I’m trying to understand to make sure you have that said as we head into ’11 and beyond.

Scott Scherr

Of the hires, not even 10%. 3% are in marketing, a lot more programs to generate, obviously more into the pipeline. There will be no hiring in marketing going into next year.

In sales, Workplace we’re going to hire four people. Two are already hired. We’re going to hire two more. That’s it. We’re set right now to make our ’11 number.

Operator

Your next question comes from Mark Murphy – Piper Jaffray.

Mark Murphy – Piper Jaffray

I wanted to ask, as you talk to your customers that are migrating off of ADT or off of Ceridian and moving over to Ultimate, what are the key points that they were experiencing with the legacy vendors and are you seeing any shift in the point sets occurred either during 2009 or in the last quarter?

Scott Scherr

I don’t want to get into it. I’d just say that if we’re talking to somebody and they’re letting us go through our process then they’re probably not happy with what they have. If they’re not happy then we have an opportunity and when we get that opportunity if we can run our process we have a 90% close rate. Do an analysis, present our solutions and then give a return on investment and a price. I don’t want to get into why.

We put out press releases every week. All you have to do is look at the ones that we say Service on with their Service Bureau, call any of them and ask them why they came to us. You’ll get that answer.

Mark Murphy – Piper Jaffray

Could you just clarify which metric is it that you’re indicating you will not disclose any longer.

Mitchell Dauerman

That was the same store employment count. We used to give the metric that would measure the absolute number of employees, a percentage number of employees that changed from December of the preceding year to the current month or the current quarter end.

Mark Murphy – Piper Jaffray

I’m just curious, did something change? Are you saying that metric was relevant in the past when you provided it but it’s no longer relevant?

Mitchell Dauerman

No. I think we started to provide it because there was some discussion out there about what was happening to our employment base, so we were probably more reactive. We always cautioned it by saying you couldn’t use that number to try to estimate recurring revenues.

As we went through the rest of the year it became clear you couldn’t use that metric alone to estimate recurring revenues. So in a sense by providing the number, it really doesn’t help you or others get to where you want to get to.

We’re giving guidance on the quarter on recurring revenues. We’re giving it on the year. I can tell you if I gave you a point to point number you wouldn’t know what happened within the months within that quarter where there could be spikes.

So all those factors do come into play in coming up with the recurring revenue, as well as contractual obligations that sometime affect those changes in employment counts and those that don’t.

Operator

Your next question comes from Raghavan Sarathy – Dougherty & Company.

Raghavan Sarathy – Dougherty & Company

On the recurring revenue for fourth quarter, when I look at the recurring revenue there was not actual raise from third quarter to fourth quarter. Also if I have my numbers right, it was probably $1 million below your implied guidance. You talked about this a little bit. I was wondering if you could give some color on what are some of the factors that impacted recurring revenue and if you could quantify that in some way.

Mitchell Dauerman

It’s really simple, and to follow up on Mark’s point. It’s changes in the employment that happened that adjusted the base and it was some continued push out of the start dates of some of the complimentary products that we estimated.

At the end of the day we didn’t lose the products and I think we have a good business plans for next year.

Raghavan Sarathy – Dougherty & Company

Just to drill down on that, you said some of the complementary products, can you give us some color on what are some of the modules that are considered discretionary and how you have factored that into your guidance for 2010 and how we should think about it in the model?

Scott Scherr

I think we try to take those into account as we look at complimentary products and what do we think as we try to model that component average time to live. So we try to take a view of what we’ve seen in the last four to six months and build that in.

Raghavan Sarathy – Dougherty & Company

In the modules, are customers pushing out more time and attendance or recruitment?

Scott Scherr

Complimentary modules are time and attendance and talent management solutions which is recruitment performance and on-boarding. There’s no concentration in on particular module if that’s why you’re asking the question.

Raghavan Sarathy – Dougherty & Company

You gave license revenue guidance for 2010 $1.4 million. What is you assumption for the first quarter?

Mitchell Dauerman

I’m modeling about $.75 million.

Operator

Your next question comes from Ilya Grozovsky – Morgan Joseph.

Ilya Grozovsky – Morgan Joseph

I had a question on your services business. That obviously came up in the quarter after two quarters down with the economy. Do you see that bouncing back from a seasonal perspective or has something changed and customers are once again interested in the services side?

Scott Scherr

First off, fourth quarter typically is a higher quarter because we have quite a few January 1 starts so that drives a lot of implementation revenue leading up to that. I think our view of services is it’s not a major contributor to the business model. The driver is get a customer up and running as fast as we can for as low a cost as we can, train them well and that will help us generate incremental and continuing recurring revenue.

Ilya Grozovsky – Morgan Joseph

So it was seasonal then.

Scott Scherr

For Q4 it is seasonal.

Operator

Your next question comes from Roy Moore – YX Funds.

Roy Moore – YX Funds

I wanted to get a little bit more clarity as to the lower margins in Q1 and what actual line items will we see the increase in expenses in. So is it primarily showing up in sales and marketing or G&A because looking back historically at the first quarter for 2009, ’08, 07 I don’t see a historical trend of an increase in expenses there.

Mitchell Dauerman

A couple of things I would point out; one is you have to take a look at the license revenue change in Q1 of each year. Again, we don’t sell new perpetual licenses. What we are getting is license revenue from existing customers and growth, but I do think if you look at the total Q4 operating expenses going to Q1, they do jump fairly significantly.

For example for 2008 they were $21.6 million in Q4, this is on a non-GAAP basis and they went up to $234.9 million. And this year it’s $24.4 million and you’ve probably done the modeling, you’re probably somewhere around $28 million. But those happen across the board.

Two-thirds of our costs are labor related and there are as I’m sure you know, there are employment taxes that kick in in the beginning of the year that the employer matches. Secondly, with the way that our vacation policy runs, people will accrue vacation pay beginning in the first quarter through the third quarter as their accruing and using, but in the fourth quarter, to the extent that they have any carry over, half of it will go away.

So normally you see, and we’ve always seen a reduction in comp expense because of the vacation accrual pay going down in the fourth quarter. So that’s what makes a significant change from Q4 to Q1 is you have the decrease in vacation pay offset or added to the increase in the employment expenses in Q1.

Operator

Your next question comes from Bradley Whitt – Broadpoint Capital.

Bradley Whitt – Broadpoint Capital

How should we think about these billing changes impacting your cash flow for this fiscal year?

Mitchell Dauerman

I think that as I said, free cash flow should still approximate the non-GAAP earnings. I mentioned I think we’ll spend about $.5 million for taxes, maybe a little bit less than that will actually be paid during the year. And the spread in D&A and Cap Ex will be about $1 million.

I think we’ll still, we need to get these billing changes through the whole system, but free cash flow should stay at that level and then should grow.

Bradley Whitt – Broadpoint Capital

Along the same lines your CapEx came in quite a bit lower this year than you originally anticipated. How should we think about that? Is there anything catch up you need to do on in the infrastructure front?

Mitchell Dauerman

I think what really happened, if you go back to ’08, we probably pulled some CapEx into ’08. Now if you remember, that number was $13 million prior to excluding purchases, so we probably had a little pull there. This year we probably set out budget a little higher than we ended up needing and then next year we’ll go back up to a little bit higher level as we do some investments, obviously continuing in the inner sourcing area, development, even my area will have some CapEx investments.

I wouldn’t ready anything into that.

Operator

There are no further questions. I’ll turn the conference back over to Mr. Dauerman for any closing remarks.

Scott Scherr

It’s Scott. Thanks for your time. We appreciate it. Take care everyone.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!