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In no event should Soapbox Research be
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Software Group’s stock and therefore stand to realize gains in the event that the price of the stock declines. Please refer to our full
disclaimer located on the last page of this report.

Summary
Ultimate Software Group (“Ultimate”, “ULTI” or “the Company”), is a HCM
(human capital management) provider. The company offers cloud-based
software that helps clients streamline talent management, HR and payroll
processes within their companies.
Sell side firms tout that ULTI has the “best margins in SaaS” and that its
“resilient business model” and “improving free cash flows” make it a
resounding Buy. Company management boasts about their ability to grow
recurring revenue by ~ 30% and double total company revenue in five
year’s time. A closer examination of the company’s financials, however,
reveals these claims to be questionable at best.
In stark contrast to the consensus views above, our analysis revealed the
following:
1. Aggressive capitalization inflates operating margins by more than double
and appears to be a backdoor way for ULTI to capitalize product
development costs.
2. Disclosures about revenue and customers do not add up and suggest that
ULTI has been grossly overstating numbers to investors.
3. Revenue exaggeration and accounting chicanery at ULTI should come as no
surprise given that the Chairman (Robert Yanover) of ULTI’s Audit
Committee was the Founder and Chairman of Lason, Inc, a company that
was charged with accounting fraud (including falsifying revenues) in 2007.
4. Stock-based compensation has grown at an accelerating pace. This has
resulted in significant cash spend on share repurchases to settle employee
tax liabilities and offset dilution which, when taken out of OCF, reveals that
OCF and FCF is actually falling precipitously.
5. The Scherr family and unrelated ULTI executives are unjustifiably enriched
at the expense of shareholders.

Company:
Ultimate
Software Group
Ticker: ULTI
Industry:
Information
Technology
Stock Price as of
8/16/2016:
$212.94
Market
Cap:$6.16bn
Daily Volume:
220,924 (3 month
avg.)
Price Target:
$101.15

We believe that once investors realize the magnitude of ULTI’s exaggerated
claims, the company should trade down to its fair value of $101.15,
implying a downside in excess of 50%.1

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As of 8/16/2016

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Aggressive (and Erroneous) Capitalization Inflates Operating Margin
Briefly stepping away from the market hype surrounding Ultimate Software to examine the Company’s
historical financials reveals that ULTI’s claims regarding its financial performance have become
exceedingly aggressive and promotional. Over the years, Ultimate’s touting has become so egregious
and their accounting so aggressive, that operating margins discussed by management are in some
cases more than double what they should be in reality!
One of the ways in which Ultimate manipulates margins is through aggressive capitalization of research
and development expenses. As the Company started to feel greater pressure on margins, Management
responded by simply capitalizing R&D instead of expensing it. This approach is reminiscent of the trick
used in the early 2000’s by WorldCom – aka one of the biggest accounting scandals in history. As a way
to improve the company’s financial performance following the dot-com crash, WorldCom executives
simply began to characterize line costs as a capital asset instead of properly recognizing them as an
operating expense. While this initially worked out well for WorldCom, once the fraud was uncovered,
the company filed for bankruptcy, its stock collapsed, and its executives were found guilty of fraud and
conspiracy.
As it relates to Ultimate, it can be seen from Figure 1 below that capitalized R&D as a portion of total
R&D has skyrocketed from 0% in Q12012 to 24% in Q22016.

To justify this aggressive capitalization, Ultimate notes that it is related to an internal-use development
project to be sold in the future and thus warrants capitalization.2 This is where management seems to
be confused. The accounting standards under GAAP specify two distinct types of software: 1) software
for internal use and 2) software to be sold, leased, or marketed. The standards provide specific AND
differing accounting treatment for each type of software. For internal use software, capitalization can
begin at the onset of development. For software that is going to be sold, leased, or marketed, however,
2

P.34 of 2013 10K, p. 10 of 2014 10K, p.11 2015 10K

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capitalization can only begin once technological feasibility is reached, i.e. later than for internal use
software. From Ultimate’s disclosures, it appears that management wants the best of both worlds: they
want to develop software that they can eventually sell and profit from but they also don’t want to bear
the development cost it takes to reach technological feasibility so they capitalize it instead. Although
this approach is indeed very convenient and quite clever, unfortunately for Ultimate, it does not
conform to GAAP. In fact, as can be seen in figure 2, if we accurately account for capitalized R&D,
margins would be more than 50% lower than those currently reported by ULTI. Also alarming is that
these margins actually turned negative for the first time in Q22016!

Not only does ULTI inappropropratly rely on the aforementioned internal-use development project to
avoid recognizing R&D expense, but in the most recent quarter the company also cited the same project
as a reason to delay amortization associated with the Vestrics Acquisition:
“Since the developed predictive technology acquired pursuant to the Vestrics Acquisition will be
included in the development project currently being capitalized as internal-use software to be
offered as a cloud product in the future, amortization of the Vestrics developed technology will
begin when it is ready for its intended use” (Ultimate Software 2Q2016 10Q, p. 7).
This rationalization appears highly suspect, and we believe that this development project is being used
as a catch all account by ULTI to prevent both R&D and amortization expenses from impacting the
bottom line.
Revenue Disclosures are Questionable
In addition to presenting inflated margins in their financial statements, ULTI’s earnings calls and
conference presentations are filled with promotional claims about their revenue generating abilities. On
the Q12016 earnings call, Scott Scherr, the Founder, Chairman and CEO of Ultimate software talked
about the Company’s recurring revenue growth:
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“I mean we basically over we've gone 14 years at 25% recurring revenue growth. I think one
year we were at, like, 23% and so I just think it's the growth of the company, the growth of the
sales organization, maintaining 97% client base, retention of our client base. Having a 95%
reference level client base.”
At the Roth Growth Conference in early 2016, Scott was back at it, boasting about growing top line:
“Now, anyone who knows us, there's no one who doesn't think we're going to blow through $1
billion in 2018. So then it becomes what's next after that. So obviously it's $2 billion, and
hopefully we think we can, if everything stays, as we are, we think, we should hit that in 2022.”
The only thing more ridiculous than forecasting $2bn in revenue seven years out (which, by the way,
implies a CAGR in excess of 18%), is that ULTI has managed to successfully convince the sell side that
these growth figures are accurate and justify a premium multiple to peers.
Deutsche Bank report dated 4/27/2016:
“Our $215 PT implies a CY17 EV/S of 6.6x, a premium to peers due to a superior combination of
growth and profitability”
Credit Suisse report dated 4/26/2016:
“ULTI currently trades at a 2016E EV/Sales multiple of 7.5x, a 88% premium to the peer group of
4.0x, which we believe is warranted given the company's track record and high degree of
visibility into future operating results (mgmt. has ~99% visibility into 2016 recurring revenue
growth guide.”
UBS report dated 4/19/2016
“The multiple is at a premium to the SaaS comp group mean EV/S, which we believe is justified
given above average rev & earnings growth (+ predictability) and superior mgns.”
While ULTI’s Management believes they are extremely transparent with investors, “But I am just saying,
again, people -- I think as a Company, we are fairly transparent with investors. We tell you
everything. Maybe sometimes we tell you too much, but, no, but we think it builds credibility that way.
(Mitch Dauerman, 3/1/16), they actually do not provide sufficient information for investors to assess the
validity of their claims about revenue or recurring revenue. However, by piecing together publicly
available information, we found gross inconsistencies in ULTI’s earnings calls and SEC filings, which
lead us to question the overall credibility of ULTI’s management and the veracity of their claims.
Ultimate Software segments its 3,200 customers into three categories: Strategic (companies with 100499 employees), Midmarket (companies with 500-1,500 employees) and Enterprise (companies with
1,500 or more employees).3 Management has stated that Strategic customers employ an average of 400
employees, Midmarket, an average of 600 to 700 employees and Enterprise, around 5,000.4 In

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Page 2 of 2015 10K
3/15/2016 Roth Conference

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Midmarket and Strategic, Ultimate earns an average of $22 per employee per month.5 In Enterprise, the
Company averages about $14 per employee per month because customers with more than 5,000
employees receive costs breaks from Ultimate.6 A summary of this data, along with a calculation of
average revenue per customer per year is presented in Figure 3.

The Company does not disclose how many of its 3,200 customers fall into each of the three segments.
We know that historically, Ultimate has been focused on Midmarket so the majority of its customers are
likely to fall into that bucket. The Strategic segment is a new category for Ultimate started in 2015, and
as such, is likely to be responsible for only a small percentage of Ultimate’s customer base. Thus, as a
starting point, we assumed a 30%/60%/10% revenue split among the Enterprise, Midmarket and
Strategic tiers, respectively. Operating under these assumptions, we tried to determine the revenue
derived from each category as well as the total revenue that Ultimate earns as presented in Figure 4.

Our results were surprising in that the total revenue in figure 4 which was calculated based on
statements made by ULTI Management is nearly 89% higher than the total revenue that the company
reported for that same period in its 2015 10K presented below:

5
6

6/9/2015 William Blair Annual Growth Stock Conference
Q2 2015 Earnings Call

5

Even if the Percentage of Customers assumption is changed between the three segments, in every
feasible case there still existed a large discrepancy between the revenue reported in the Company’s 10K
and the revenue implied in its earnings call disclosures as demonstrated by our analysis in Figure 5.

We question how investors and sell side analysts can take ULTI’s promotional earnings calls and seven
year forecasts seriously and use them for justifying a premium multiple when there is clear evidence
that the Company is either blatantly lying or too incompetent to accurately convey UTLI’s true
performance to the market???
Chairman of ULTI’s Audit Committee Involved with Lason Fraud
Robert Yanover, 79, has served on Ultimate Software’s Board since January 1997 and is Chairman of the
Audit Committee and a member of the Compensation Committee. Prior to joining ULTI’s Board, Yanover
founded Lason Inc, a Michigan-based imaging company. Yanover served as Chairman of Lason’s Board
from its inception until 1998 and again from 2000 until 2001. He was also Director of Lason from its
inception until 2001. Yanover announced his resignation from Lason’s Board on February 21, 2001 citing
health reasons, all the while continuing to serve on ULTI’s board.

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During Yanover’s reign as Chairman, Lason was a Wall Street darling. It reported significant annual
revenue growth and expanding EBITDA margins while its stock appreciated 185% in the course of two
years – a narrative very similar to that of ULTI. However, things disintegrated quickly for Lason as it
was found to be cooking the books, in what was at the time referred to as “one of the worst
accounting frauds ever.”7 ULTI does not disclose Yanover’s checkered past to shareholders.
Prosecutors alleged that from approximately 1997 through early 2000 (during Yanover’s tenure), Lason’s
success was largely due to accounting shenanigans which was primarily orchestrated by William
Rauwerdink, Lason’s CFO, who was hired by the Board in 1996 (also during Yanover’s tenure) just
months after he had been sanctioned and fined by the SEC over insider trading allegations at his
previous employer. The scheme at Lason initially relied on manipulating financials from newly acquired
companies to inflate Lason earnings. However, as acquisitions slowed, this trick alone was not sufficient
to meet Wall Street estimates, so Lason simply made up revenues from work that wasn’t real and then
bragged about their amazing results to investors.
While Yanover was not one of the three executives formally charged at Lason, this raises serious
questions about Yanover’s oversight abilities, as three executives at his company successfully
perpetrated fraud right under his nose. Additionally, considering that he resigned from Lason’s board
over 15 years ago due to health reasons, we find it questionable that ULTI Management continues to
find him fit to serve on their Board.
Perhaps an explanation for Yanover’s appointment is that Scott Scherr is just simply too distracted to
properly vet his board members. A search for companies registered to Ultimate’s address revealed
various outside entities with which Scott Scherr and Ultimate Software are associated – none of which
are disclosed to investors. First up is Casey Taryn, LLC that in 2015 was managed by Casey and Scott
Scherr. In 2015, this same entity (and its associated company Ass Armor) were accused of trademark
infringement, trademark dilution, unfair competition and cybersquatting by Under Armour. See the
filing from the Florida Department of State below and excerpts from the complaint on the following
page.

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http://articles.chicagotribune.com/2014-01-20/news/ct-rauner-lason-met-20140120_1_bruce-rauner-gtcr-firm

7

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In addition to Casey Taryn LLC, Scott Scherr managed SV World LLC until 2012. Then, the business was
dually managed by Scott Scherr and Vivian Maza before Vivian took over as the sole manager in 2015.
Vivian’s involvement is especially interesting since she is also listed as the Chief People Officer and
Company Secretary of ULTI, and also appears to be part of Scott Scherr’s family (more on this on page 12
of this report).

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Finally, Scott also manages MJDCL Management LLC. Unfortunately for us, disclosure on MJDCL is
limited and the company does not seem to be involved in any lawsuits with multi-billion companies so
its actual business activities remain a mystery.

With all of these outside business activities to manage, it is no surprise that Ultimate must rely on
financial trickery rather than sound management to run its business.
Stock Based Compensation Used to Enrich Management and Trick Investors
In addition to shady revenue disclosures and contentious capitalization methods, Ultimate also relies
heavily on stock based compensation (“SBC”) and related share repurchases to help it further embellish
its financials and simultaneously enrich management. As can be seen from figure 6, stock based
compensation as a percentage of revenue has increased significantly from 5.6% of revenue in Q12012 to
15.4% of revenue in Q22016.

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ULTI management adds back stock based compensation when it talks about its “impressive and
growing” non-GAAP operating margin (which is unsurprisingly the only operating margin we ever found
mentioned on calls and presentations). However, if we adjust this supposedly amazing margin for
abnormal SBC (NB: in our analysis we assume that any SBC in excess of 5.6% of sales should be
subtracted to allow for a like-for-like comparison from 2012 to present) and the aggressive capitalization
we discussed earlier, we see that actually, ULTI’s margins are in a rapid decline and significantly worse
than those promoted by management. See figure 7 below:

As a result of ULTI’s exorbitant stock based compensation, the company has to continually spend cash to
settle employee tax liabilities and offset dilution resulting from stock rewards. While this cash outflow is
tied to employee compensation which is by all accounting standards an operating expense, ULTI chooses
to instead classify the related cash outflows as cash flow from financing. Let’s not forget this is under the
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watchful eye of a man who has already failed to identify a fraud in the past. Consequently, ULTI’s cash
flow from operations and free cash flow (“FCF”) figures are inflated. Correctly adjusting for this shows
that ULTI’s operating and free cash flow have been in rapid decline for the past two years (Figure 8 and
9).

Company Performance Does Not Warrant Executive Compensation
One would expect that in a company with shrinking margins and deteriorating cash flows,
management’s compensation would be modest and in step with performance metrics. At ULTI,
however, we find just the opposite to be true. As disclosed in Ultimate Software’s 2015 Proxy (and
replicated in Figure 10, Scott Scherr’s total compensation more than tripled from 2014 to 2015 while the
rest of management saw their compensation double!

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To put this excess in perspective, in 2015 Scott Scherr’s total compensation exceeded the entire net
income of the Company, and the Scherr family (Marc and Scott are brothers and Adam Rogers is Scott’s
son-in-law) received a total compensation significantly in excess of the total operating income that ULTI
reported that year!
We point out that the Scherr family’s exorbitant compensation would be even higher if we included
Vivian Maza in the calculation. Vivian is the Chief People Officer and Company Secretary at Ultimate.
While Ultimate does not disclose Vivian’s Scherr family ties, deed records filed with Broward County
show a number of property transactions classified as intrafamily transfers that took place between Scott
and Vivian. Additionally, various public record searches reveal that the two lived at the same address
leading us to conclude that Scott and Vivian are family.
You would think that a company which deems itself to be overly transparent with its investors would’ve
mentioned that one of its key employees has familial ties to the CEO.
Valuation
We believe that once ULTI’s exaggerated claims and financial trickery come to light, ULTI’s stock should
fall by more than 50% from its current valuation8 to $101.15
We based our valuation on median 2016, 2017, and 2018 EBITDA and FCF multiples of comparable SaaS
companies9 as well as two additional prominent HCM providers: Automatic Data Processing Inc and
Paychex.
To forecast EBITDA, we started with Bloomberg consensus estimates for EBIT. Then, based on our
earlier discussion of ULTI’s wrongful capitalization of R&D on pages 2-3 of this report, we adjusted
consensus EBIT downward to correctly expense instead of capitalize R&D. We then added back the
8
9

Current as of 8/16/2016
SaaS comparables consist of: Cornerstone Ondemand, Paycom, Paylocity, Salesforce.Com, and Workday

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forecasted depreciation and amortization implied by the difference in sell side EBITDA and EBIT
estimates to arrive at 2016, 2017 and 2018 EBITDA estimates. To these estimates, we applied the comp
group’s median 2016, 2017 and 2018 EV / EBITDA multiples of 36.3x, 28.1x, and 25.1x, respectively,
which we might add are significantly higher than ULTI’s respective multiples of 31.3x, 24.9x and 20.1x,
highlighting the conservative nature of our approach.
To forecast free cash flow, we started by looking at historic and forward estimates of ULTI’s free cash
flow, based on Bloomberg consensus. We then compared the historic free cash flow numbers to the
true historic FCF we derived in our discussion on pages 11-12 of this report going back to 2012. We
found that on average, ULTI’s true free cash flows were 56% of the reported numbers in 2012-2016. As
such, we applied this same factor to the 2016, 2017 and 2018 Bloomberg consensus free cash flow
estimates to derive what we believe to be true free cash flow. We then applied the FCF median yield of
the comp group to our estimates to come up with a target share price.
Finally, we averaged all the derived target share prices to come up with our target of $101.15 Figure 11
more clearly illustrates our process.

Conclusion

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This report presents a preponderance of evidence to support our less than underwhelming opinion of
Ultimate Software and a $101.15 price target.
Since 2012, the company has grown more reliant on a number of questionable accounting techniques
(aggressive capitalization, cash flow inflation) and exaggerated claims to mask its deteriorating
performance. Its audit board is chaired by a man who was the founder and Chairman of a company that
was deemed to be one of the worst ever accounting frauds, and its management, despite claiming to be
overly transparent has not been upfront with the investment community. All of these factors, make ULTI
an ultimate sell.

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