The Ultimate Software Group Management Discusses Q2 2013 Results - Earnings Call Transcript

Jul.30.13 | About: Ultimate Software (ULTI)

The Ultimate Software Group (NASDAQ:ULTI)

Q2 2013 Earnings Call

July 30, 2013 5:00 pm ET

Executives

Mitchell K. Dauerman - Chief Financial Officer, Principal Accounting Officer, Executive Vice President and Treasurer

Scott Scherr - Founder, Chairman, Chief Executive Officer, President and Chairman of Executive Committee

Analysts

Michael B. Nemeroff - Crédit Suisse AG, Research Division

Justin A. Furby - William Blair & Company L.L.C., Research Division

Richard K. Baldry - Wunderlich Securities Inc., Research Division

Scott R. Berg - Northland Capital Markets, Research Division

Frank Robinson - Goldman Sachs Group Inc., Research Division

Mark R. Murphy - Piper Jaffray Companies, Research Division

Jeffrey L. Houston - Barrington Research Associates, Inc., Research Division

Bradley H. Sills - Maxim Group LLC, Research Division

Nathan Schneiderman - Roth Capital Partners, LLC, Research Division

Raghavan Sarathy - Dougherty & Company LLC, Research Division

Steven R. Koenig - Wedbush Securities Inc., Research Division

Mark S. Marcon - Robert W. Baird & Co. Incorporated, Research Division

Brian J. Schwartz - Oppenheimer & Co. Inc., Research Division

Operator

Hello, and welcome to Ultimate's Second Quarter Financial Results 2013 Conference Call. [Operator Instructions] Today's conference is being recorded. Your presenters today will be: Mr. Scott Scherr, Chief Executive Officer, President and Founder of Ultimate; and Mitchell K. Dauerman, Executive Vice President and Chief Financial Officer. We will begin with comments from Mitchell Dauerman. Please go ahead, sir.

Mitchell K. Dauerman

Thank you, Melissa. 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 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 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 statement, whether as a result of new information, future events or otherwise.

I'm going to begin by reviewing our financial results for the second quarter of 2013, and then I'll provide financial guidance for the third quarter. Unless otherwise noted, our discussion will be on a non-GAAP basis for all costs, gross margins, operating and net income, as well as EPS. The primary difference between GAAP and non-GAAP financial information is noncash stock-based compensation. 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 quarter, total revenues grew by 23.1% to $97.5 million, and recurring revenues grew by 24.9% to $80.8 million. Recurring revenues as a percentage of total revenues increased to 83% from 82% in the second quarter 2012, and our customer retention remained in excess of 96%. Total gross margin was 60.2%, compared with 58.5% for the second quarter of 2012. Operating income increased to $16.8 million, and the operating margin for the quarter expanded by 420 basis points to 17.2% compared with Q2 of last year. Net income grew to $9.7 million compared with $5.9 million last year. The related net earnings per diluted share were $0.34 for Q2 of this year, compared with $0.21 per diluted share in the second quarter of 2012.

Our cash flows from operating activities for the first half of 2013 grew 43% to $32.5 million from $22.7 million in the prior year. Our cash and marketable securities balance grew $21.7 million in the last 6 months to $91.1 million at June 30 as compared with $69.4 million at year end, excluding our payment service customer funds. The average daily float balance for our payment services business for the first half of 2013 was $460 million.

Our recurring revenue results were in line with our expectations. The recurring revenue gross margin of 73.3% was better than our expectations. This was driven by lower recurring costs, which were largely due to leveraging both our payment services and our cloud delivery operations. Service revenues were $16.4 million and the related gross margin were in line with our expectations. The gross margin rate for total revenues of 60.2%, compared with 58.5% in the second quarter of last year. The increase was a result of a revenue mix shift favoring higher margin recurring revenues.

Operating expenses were $41.9 million for the quarter, and they were in line with our expectations. Operating income was $16.8 million and our operating margin was 17.2% for the quarter. Net income was $9.7 million or $0.34 per diluted share, compared with $5.9 million and $0.21 per diluted share for the same quarter last year. Our non-GAAP income tax rate was 42%.

Turning to the balance sheet. Our capital expenditures for the first 6 months of 2013 were $14.1 million, including capitalized R&D costs of approximately $6.6 million, compared with $7.4 million in capital expenditures for the same period last year. There were no capitalized R&D costs in the first half of 2012, since capitalization for this project began in Q3 of 2012. We used $6.7 million for the quarter to acquire roughly 69,000 shares of our common stock to settle employees tax withholding obligations associated with the restricted stock that vested in the first half of 2013. We have 946,000 shares available for repurchase under our stock repurchase plan.

Accounts receivable increased to $70.7 million, compared with $53.7 million at June 30 last year. DSOs were 66 days compared with 62 days for the comparable period last year. Current deferred revenues were $93.1 million on June 30 compared to $82.7 million at June 30 last year. Long-term deferred revenues were $900,000 on June 30, compared with $2.1 million on June 30 last year, reflecting the elimination of onetime infrastructure fees in our cloud contracts.

Next, I'd like to discuss our guidance. We are reaffirming our full year guidance for 2013. Recurring revenues are expected to grow by approximately 25%. Total revenues are expected to grow by approximately 23%. And our operating margin is expected to be approximately 17%. For the third quarter 2013, we expect recurring revenues to be approximately $84 million. We expect total revenues to be approximately $103 million. And we expect our operating margin for the third quarter to be approximately 18%.

Turning to our upcoming conference schedule. During the next quarter, I will be at Needham's Software Conference in New York on August 6, in Boston at -- for the Oppenheimer Technology Conference and Canaccord Genuity Growth Conference on August 14 and 15. I'll also be at Barrington's Growth Conference in Chicago on September 4, Deutsche Bank's tech conference in Las Vegas on September 10 and the Credit Suisse small mid cap conference in New York on September 17. 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, Mitch. And thank you, everyone, for participating on our call this evening. Our Q2 results were in line with our expectations and our 2013 goal. Recurring revenues increased by 25% over those in Q2 of 2012 to $81 million. Total revenues were $97.5 million, an increase of 23% over the second quarter last year. And our customer retention rate continued to exceed 96% for the trailing 12 months ending with Q2. Our enterprise team's attach rates for our add-on solutions in Q2 remained healthy, with recruitment at 74%, onboarding at 65%, performance management at 61% and time management at 48%. Some of our new enterprise customers in the second quarter were: a retailer with 9,000 employees that added recruitment, onboarding, employee relations and time management to Core UltiPro; a restaurant group with more than 700,000 employees that added recruitment, onboarding and performance management; an energy company with 6,500 employees; an airline company with 5,000 employees that added recruitment; and a financial services company with approximately 5,000 employees that added recruitment, onboarding, performance management, salary planning and budgeting and succession management. We continued to have success converting a significant number of our legacy on-site customers to the cloud, including some larger organizations such as: A 15,000-employee energy services company that added our global feature set in the new contract; a 12,000-employee food and beverage distributor that also added global; and an 8,000-employee manufacturer.

Our Workplace team's Q2 attach rates also remained healthy: Recruitment, 64%; onboarding, 70%; performance management, 51%; and time management, 74%. Some new Workplace customers in the quarter were: An equipment dealer, with 1,000 employees and more than 50 locations, that added recruitment, onboarding, performance management, salary planning and budgeting and succession management to the core solution; a financial services firm with 1,000 employees that added recruitment, onboarding, salary planning and budgeting, time management and UltiPro Canada; a multistate truck dealer with nearly 1,000 employees that added recruitment, onboarding and time management; another equipment dealer with more than 900 employees that added onboarding, performance management, salary, planning and budgeting and succession management; and a mortgage company that added recruitment, onboarding, performance management and time management.

I attended our semiannual sales meetings in July. Mid-year meetings are always high energy, and this year did not disappoint. We are staffed with very talented players on both our Enterprise and Workplace teams, and many are excited about the prospects they are working and confident in achieving their 2013 goals. Our pipelines continue to grow, and our marketing metrics for Q2 2013 indicate the strongest interest in our solutions that we've had in our history. We had the largest number ever of prospects looking to purchase in 12 months or less in the quarter. This represents a 25% increase over Q1 of this year and a 28% increase over 2012's Q2. Our website traffic was up 17% over 2012's Q2 and was the second highest quarter in our history. And the number of opportunities uncovered by our inside sales team was up 25% over 2012's Q2. Our customer referenceability remains very strong. In the spring survey, more than 80% of our customers said they would recommend UltiPro to a colleague. Of customers who attended our 2013 Connections Conference, 90% said they would recommend UltiPro. At the same time, our percentage of satisfied or very satisfied UltiPro primary users remained consistent for the last 12 months at 90%.

Constellation Research, an independent research and advisory firm, published a review of Ultimate in Q2 as part of its Cloud Buyers Bill of Rights Certification, which is intended to help buyers of enterprise cloud apps enter into contracts as long-term partners with their vendors. Out of a possible score of 5.0, Ultimate received a score of 4.8, the highest cloud vendor score to date. Constellation called Ultimate's status epic, the highest level of certification. Constellation evaluated Ultimate on 61 criteria in 4 main categories: Ownership experience; use case support; corporate vision; and ecosystem feedback.

Ultimate also received an innovation award from Informatica in the quarter. Winners were selected from more than 5,000 Informatica customers and were recognized for exemplary data integration and data management results and business outcomes. Ultimate won in the Cloud Integration category for our development team's work on the UltiPro carrier network that can cut integration project duration times for our customers by 50%, reducing their technical expenses and increasing our customer satisfaction.

In Q2, Ultimate celebrated 15 years as a public company. Over the past 15 years, we have grown from a little over 300 employees to 1,735 employees at the close of Q2. Today, we support more than 2,500 businesses, whose operations span 144 countries. Ultimate pioneered our industry's move to the cloud in 2002, as the first HR payroll provider to offer our software on a SaaS basis. Today, we continue to lead the human capital management industry by providing a comprehensive strategic suite of HR, payroll, time and talent management solutions. We manage more than 10 million people records in our cloud for some of the world's most respected brands. Brands like Adobe, Culligan International, The Fresh Market, NVIDIA, Nikon, Outback Steakhouse, P.F. Chang's, Revlon and Texas Roadhouse. 15 years ago, we had a people-first culture, and we continue to be a people-first culture today, recognized as one of Fortune Magazine's Top 10 Best Companies to Work For in America.

We have more opportunities before us than we've ever had, and we are excited to continue innovating and growing. And our first half performance puts us in good position to achieve our 2013 objectives and leaves a strong foundation for our 2014 goal. Our journey continues stronger than ever. Thank you for your continued support. Let's go to the Q&A.

Question-and-Answer Session

Operator

[Operator Instructions] And our first question will come from Michael Nemeroff from Crédit Suisse.

Michael B. Nemeroff - Crédit Suisse AG, Research Division

One for Scott, one for Mitch. Scott, you've got some new product that's going to come -- start rolling out towards the end of the year and into next year. I was wondering if you give us a little bit more of a detailed update on timing, when the modules are coming out, what we can expect? And also, if you think that maybe this could drive some sort of a product cycle for modules that customers don't have, as the new ones get released. And then I have a follow-up for Mitch, please.

Scott Scherr

Yes, well, the first module we're coming out with is recruitment. We've said that. It's scheduled to come out the first half of 2014, and that will be the first module of our next generation product suite. So it's on schedule, it's on time, and it looks great.

Michael B. Nemeroff - Crédit Suisse AG, Research Division

And how many other ---- are there other modules that are going to be released in 2014 as well?

Scott Scherr

I believe so. I really don't want to get into that. We see how recruitment goes. We get out. We're on schedule and everything goes right, and then we'll follow it with another module in '14.

Michael B. Nemeroff - Crédit Suisse AG, Research Division

Okay, fair enough. Then Mitch, 6 great quarters now of beating -- on your operating margin guidance. Just kind of curious, at what point in time, what peak operating margin do you think you have over the next couple of years, or target operating margins you think you can get to within the next, say 3 to 5 years, assuming the same growth rates that you have currently?

Mitchell K. Dauerman

I think we, beginning a couple years ago, we stopped talking about the out years, because different factors come up. We do believe strongly that the company should be profitable. We believe that operating margins should continue to expand. We think there are other companies that have grown for a long time using a recurring revenue model, and have continuously improved their operating margins. That's kind of a benchmark for us. You could probably look at this year's expansion, and we think, maybe that will be reasonable. But we'll give you more clarity on 2014. But again, directionally, we focus on growing recurring revenue, getting to $600 million in 2015 in total, $1 billion in 2018, and along the way, expanding operating margins.

Operator

Our next question will come from Justin Furby with William Blair and Company.

Justin A. Furby - William Blair & Company L.L.C., Research Division

I guess following on the -- following up on the new product. Scott, if you could talk a little bit up -- from a go-to-market perspective, are your sales reps out there talking about the new product road map? And I'm just curious, what the implications are? Does that -- are customers more apt to buy? Are they more apt to push out until they start seeing the new product? Or how does that impact you guys from a go-to-market?

Scott Scherr

I don't think it impacts us at all. In our history, everyone wants to know your road map, so this, we are showing our road map. We've always shown our road map. We'll continue to show the road map. I think the key in sales is to get people to trust what you have, and to trust where you're going, so. We'll always do that.

Justin A. Furby - William Blair & Company L.L.C., Research Division

Okay. And then competitively, I'm just curious what you're seeing from Ceridian and from Dayforce. It sounds like they're at least being somewhat aggressive on a marketing standpoint. Are you seeing them more in the market? And I'm just curious if you've seen any impact on your win rates against Ceridian.

Scott Scherr

I don't think any more than we have in the past. We've always seen the 2 big service bureaus the most. Ceridian's the #2 company, we see, they continue to be the #2 company that we see. But I haven't seen any difference in the percentages than when we're up against them, or our win rates when we're against them.

Justin A. Furby - William Blair & Company L.L.C., Research Division

Okay. And then just for you, if you think about, kind of what you've booked so far in the first half of the year in the pipeline, going forward for H2, just trying to get a sense of your confidence level, when you give that first book on the '14 numbers next quarter, whether you think you can do another year of 25% type growth on the recurring line?

Scott Scherr

I think just that, I think, like we've always done, we'll give preliminary guidance in October, and we'll give you a view into that. As I said before, our goal is to hit the $600 million in 2015. As far as the second half of the year, we're over 99% visible into that.

Operator

And we'll now go to Richard Baldry with Wunderlich.

Richard K. Baldry - Wunderlich Securities Inc., Research Division

You had great earnings number and [indiscernible] sales and marketing in prior years had gone down maybe $1 million plus sequentially. This year, it's only down a couple of hundred thousand. Can you talk about that line, whether there's more heads brought in, and there's any unusual marketing events, things like that, that kept that line up in Q2?

Mitchell K. Dauerman

Rich, this probably has to do with the addition of some marketing expenses that -- yes, we talked about increasing, with Q1 being favorable operating margins, and in addition, bringing on some additional sales heads a little bit earlier in the year than we expected.

Scott Scherr

But also, I'm continuing to invest in marketing. We've given them more dollars in Q2, right from the beginning of Q2, to do more events. Also, we have an internal sale program that has been very successful for us, and we've had 9 reps, and I'm aggressively doubling that group by the end of the year. So there are investments going there. I think now is the time to do it.

Operator

Our next question will come from Scott Berg with Northern Capital Markets.

Scott R. Berg - Northland Capital Markets, Research Division

Scott, first of all on the operating margin outperformance in the first half, kind of a continuing line of thought a little bit, is, given the significant, I guess, outperformance in those 2 quarters and the reiteration for the full year, what additional growth investments are you making to, I guess, offset kind of that balance?

Scott Scherr

Yes, as I just said, we're doubling our internal sales representatives. They're the ones who -- basically they bang on the phones to try and get opportunities for our quota-carrying salespeople. So I'm doubling that. We've accelerated our entry into Canada. We're completely staffed with our 2014 goals in Canada, which we do not anticipate being staffed for that until the end of the year. But I think because of how we were going. We just staffed it earlier. And I've given marketing additional money to expand all our marketing efforts. I think, great, those are the 3 main things.

Scott R. Berg - Northland Capital Markets, Research Division

Then a -- last follow-up question here is on the pipeline commentary that you made, Scott, on the number of prospects that intend to buy over the next 12 months, up 25% from Q1. Was there any change to the indication on what those customers are seeking to purchase? Or is it a similar set of products and add-on modules versus what you've seen over the last recent couple of quarters?

Scott Scherr

It's the same, but remember with us, everything starts with payroll, then it's HR payroll. Then it's a unified talent management, time management, tax suite. So it always starts with payroll, then goes to HR, then goes to talent, time and then tax.

Operator

And Greg Dunham with Goldman Sachs has our next question.

Frank Robinson - Goldman Sachs Group Inc., Research Division

You have Frank Robinson here for Greg Dunham. First question is, it seems like the recurring revenue margin, kind of flat-ish the last 3 quarters. And I want to know, going forward, do you think you can continue to see improvements, even if it's longer term or shorter term, whether it's like a normalized level?

Mitchell K. Dauerman

I would say right now it's -- it could be normalized. We have been doing a little bit better than we've been modeling. As I mentioned, I think I mentioned in the call, we continue to experience some better cost in cloud delivery, but also in the payment services. So that I think, probably for the rest of the year, we'd probably say around flat.

Frank Robinson - Goldman Sachs Group Inc., Research Division

Okay. And just one more for me. On the per employee per month pricing, I know last quarter, you said it was at an all-time high. Was there any significant change there? Is there a new high? Or how is that tracking?

Scott Scherr

No, I think it's just been consistent with that.

Operator

Our next question will come from Mark Murphy with Piper Jaffray.

Mark R. Murphy - Piper Jaffray Companies, Research Division

Could you remind me on the customer retention rate, which has been around 96%. Is that for the inter-sourcing customers only, or is that including the on-premise customers?

Mitchell K. Dauerman

It includes our entire customer base. And the calculation that we do, is we take the annual recurring revenue of the customers that have left us here in the 12 months ended, in this case, June 20. And we divide it into the recurring revenue run rate as of the last month of the prior quarter -- or the first month of the prior quarter. So that would be March. And that's how we get there. We've done that consistently. So it's always customers that left, and we never include any incrementals, what people call seeds of products.

Mark R. Murphy - Piper Jaffray Companies, Research Division

And then, do you expect that to remain around this 96% level, through the deadline period for the on-premise customers to convert? Or is it possible that, that would have just a temporary, small impact on the renewal -- on the retention rate?

Scott Scherr

I mean, I'd be surprised if it had an impact, other than a positive impact over the -- we went back over the last 30 months, and we have about an 80% conversion rate of clients to SaaS. From there, our remaining SaaS right now is about 3.5% of our recurring revenue. We sold more upgrades to SaaS the first 6 months of this year than all of last year, so the program is going extremely well. I don't know why it would stop going well. If it did, I would be surprised. So -- not that I couldn't be surprised, but I don't think I will be.

Mark R. Murphy - Piper Jaffray Companies, Research Division

Okay, yes, that's great to hear. I appreciate that. And Scott, and just as a follow-up, I wanted to ask you at a very high level, are there any areas of healthy internal debate about the business strategy or the road map? And the reason that I ask is that I think externally, the path forward seems so clear and simple, where you take business from the service bureaus, you maintain a strong culture. You grow recurring revenue exactly 25% every year. And I'm just wondering, are there any unique opinions internally just with respect to how quickly you hire, new product areas, the international expansion or anything else?

Scott Scherr

I think it just goes on all the time. We're always thinking on the product set, on the service set, how can we make it better, how can we grow, how can we grow our PEPM. When we got into SaaS in 2002, the opportunity was $5 per employee per month. It was HR payroll, employee, self-service and manager self-service. Today, if somebody bought every single thing we had to offer, it would be $26 per employee per month. So that goes on all the time, and we use our customers. We use our internal talent. We use the analyst community to figure out, like, what do we have to do? And then, internally, we try and build so that we can do it with speed, like get there fast. If we do see something that we want to go to, that we can get there fast.

Operator

And we'll now take a question from Jeff Houston with Barrington Research.

Jeffrey L. Houston - Barrington Research Associates, Inc., Research Division

To begin with, regarding the float balance, I think you said the average was about $460 million for the first half of the year. As rates increase, assuming that they do, and so does interest income, do you anticipate investing that back into the business or delivering more earnings or maybe buying back more stock? Just some color there would be great.

Mitchell K. Dauerman

[indiscernible] Yes, I think just like we build a model every year, we'll factor in or to model. Fundamentally, we do believe the company should expand operating margins, so there'll be a combination of investment back into the business. The way I think of it, it's just one part of the revenue stream.

Jeffrey L. Houston - Barrington Research Associates, Inc., Research Division

Okay. Then separately, switching to international expansion. I know that you've already made some progress moving into Canada with payroll. But moving beyond the U.S. and Canada with payroll, is that within the cards over the next few years? Or is international expansion mostly going to be with the talent management suite?

Scott Scherr

It's going to be with the HR and talent management. We have no plans to expand payroll outside North America at this time.

Jeffrey L. Houston - Barrington Research Associates, Inc., Research Division

Okay. Then a last question, could you talk a little bit about the hiring environment at your customers in the quarter? Were they roughly in line with your expectations or did they exceed it a bit?

Scott Scherr

They were roughly in line. It wasn't -- it was pretty modest.

Operator

And we'll now go to Brad Sills with Maxim Group.

Bradley H. Sills - Maxim Group LLC, Research Division

Just a question on the pipeline. It sounds like some very healthy activity there. Are there any verticals that you're seeing more traction, maybe some momentum here? You mentioned during the quarter, retail, restaurants, energy were healthy. Any change from kind of the activity you've seen currently?

Scott Scherr

I don't think so. I think, if you ask me what were we strongest in, I would immediately, in my mind as was you were talking, I was thinking hospitality, retail, health care, really horizontal, everyone who's interested in HR, payroll, talent and the rest of what we have to offer is a prospect for us. We do seem to get the most out of hospitality, retail and health care.

Bradley H. Sills - Maxim Group LLC, Research Division

Okay, great. And you came in, in line with where we were modeled on, sales and marketing as a percentage of revenue. Could you just comment a little bit on your ability to find the right salespeople in your hiring plans, is that kind of coming in, in line with expectations? Are you finding it more difficult in this environment to hire the right talent to kind of support your growth and expansion plans?

Scott Scherr

We've never found it hard to find the right sales person, because only a very little turnover in sales. When we have one, we're looking for one specific person in one specific territory. So typically, we get ample opportunity to find the right person. So, we've never had a problem with it, and I don't foresee us having a problem with that in the future.

Operator

And now we'll go to Nathan Schneiderman with Roth Capital.

Nathan Schneiderman - Roth Capital Partners, LLC, Research Division

Scott, previously, you had said that if you were pacing to higher-than-expected levels of operating margin, you might invest the difference in more sales hiring and marketing programs, et cetera. And it sounds like that's what's going on. So I wanted to, just as a clarification question, I wanted to be clear that, that's what's going on in the second half, as opposed to just some expenses you were expecting in the first half, just follow in the second.

Scott Scherr

I think it's a combination, but more -- a lot of marketing, will let you know, inside sales reps, I think is sales. They do make a difference, and I think they can make a bigger difference going forward. I think we've accelerated sales hiring, as I mentioned, in Canada, which I probably wouldn't have done as fast. So I think it's a combination of both, knowing that, so we're usually confident we're going to hit our guidance on the operating margin line, so just giving us the option to do what we're doing.

Nathan Schneiderman - Roth Capital Partners, LLC, Research Division

Do have any overage and the ability to invest earlier in the cycle than you would have otherwise? I guess that might imply that either you're going to have an easier time meeting your 25% goal, or you can run hot of that, just because you have the capacity in place earlier?

Scott Scherr

This is all built into the future. I'm building for 2013, it's building for '14, '15 and beyond, so...

Nathan Schneiderman - Roth Capital Partners, LLC, Research Division

Final question for you. Just -- I was hoping you could speak to some extent on big deals, success in Q2, anything interesting there? And then, just what are you seeing in the pipeline as far as big deals? You had a few last year that really helped. I'm just curious what you're seeing out there.

Scott Scherr

Yes, I think the pipeline continues to grow. I think we -- we made -- we talked about the big deals last year, because 2 of them happen to be starting in Q4 of last year. But I think, we're always going to get the opportunities for big deals, and I believe that if the opportunity is right, then I believe we have a very good chance of getting it. So the pipeline continues to grow, as we grow. It just puts us in more opportunities for that. But our business is not based on getting big deals. It's based on getting units and our people executing and doing their jobs in the field. Not that big deals aren't nice, they are. But it has to be a right fit with the right customer, that's a win for both of us. Does that answer it, Nate?

Nathan Schneiderman - Roth Capital Partners, LLC, Research Division

Yes.

Operator

And now we'll take a question from Brian Schwartz with Oppenheimer.

[Technical Difficulty]

Operator

Right, we seem to have lost Mr. Schwartz before asking his question. So we'll move on to Raghavan Sarathy with Dougherty & Company.

Raghavan Sarathy - Dougherty & Company LLC, Research Division

A couple of questions, so we'll -- first question's for Mitch. So on the full year recurring revenue growth, so your guidance implies that you're expecting an acceleration in revenue growth, sequential growth from third quarter to fourth quarter. And I -- this happened last year, when you had a few large customers going live. But can you talk about sort of the expectations here and what's driving that expectation?

Mitchell K. Dauerman

Going from second to third quarter this -- I would say there's nothing's unusual. It's the way the deals are going. They're going live.

Raghavan Sarathy - Dougherty & Company LLC, Research Division

It's actually -- I'm talking about third to fourth quarter. If you look at the implied sequential growth from third to fourth quarter, you are expecting an acceleration.

Mitchell K. Dauerman

Acceleration?

Raghavan Sarathy - Dougherty & Company LLC, Research Division

Yes, you're looking at 4% sequential growth for the third quarter and roughly 7% for the fourth quarter. This happened last year, but you had large customers go live at the time. So I'm just kind of wondering if that is [indiscernible] explain out here.

Mitchell K. Dauerman

Rav, we've been preparing the model the same way for years. It's a combination of when the deals fall, where they're going live, the carryforward from when they go live in a prior quarter. There's nothing unusual that I can think of in Q4. On a sequential basis, as Scott kind of alluded to, compared to the Q4 of the prior year, we do have the anomaly where last year, we had 2 large deals that began full revenue recognition in Q4, which is unusual. And then, that will become a tough compare for this Q4, where the growth rate year-over-year will be lower, as we expected from the beginning of the year. But I don't -- I don't know -- what other color I can give you on Q3 to Q4.

Raghavan Sarathy - Dougherty & Company LLC, Research Division

Okay, and then sort of moving on to the operating margin, Scott, you talked about investments in marketing in Canada. So again, so I guess, I'm trying to tie this into the linearity that I've seen in operating margins here, expecting the margins to go up in the third quarter, but then, expecting that to decline in the fourth quarter because you're guiding for 17% for the full year, which is where you are at now. So does the second quarter reflect the full level of expenses? Again, I think looking at the fourth quarter [indiscernible] different dynamics [indiscernible] from a margin perspective, too.

Mitchell K. Dauerman

So the first thing I would say is, the above-expectation performance in the first half is a combination of some permanent items. We talked about cloud delivering payment services, and some timing items. As we began in the second quarter, and we expect it to continue. And Scott discussed, we'll invest more heavily in sales and marketing. There'll be some timing items that will flip around. But I think as you know, and many people that have been involved with us for a long time, we maintain one plan, both internally and externally, for the full year. Our focus is obviously on achieving that plan, but also looking forward and setting up the table to continue the recurring revenue growth, to keep retention above 95% in the long term and to expand operating margins. When we give guidance next quarter, they'll see where we fall out for the year. But again, I think you may be focusing a little too narrowly and too much in the short term, when where we're focusing on, we have a business plan, this is what everybody in the company is marching to, but we're really looking at a longer-term picture.

Operator

And our next question will come from Steve Koenig with Wedbush Securities.

Steven R. Koenig - Wedbush Securities Inc., Research Division

Just one and then one follow-up. I'd love to get a little color on new business activity in the quarter. And then, and also just generally speaking, are -- remind me, are Q2 and Q3, the big quarters for new payroll deals? And then talk a little bit about this Q2, relative to new business activity. How do you do relative to your expectations for closing new business?

Scott Scherr

Well, the sales team hit my expectations. We had a good Q2. We had a good first half. Pipelines are strong. I feel good about the second half.

Steven R. Koenig - Wedbush Securities Inc., Research Division

Okay. And remind me, Scott, are Q2 and Q3, are these typically the biggest quarters for you guys in terms of new customers, new deal intake?

Mitchell K. Dauerman

We normally go -- it could flip. But 2, 3 or 3, 2, then 4, 1 is how it typically goes.

Steven R. Koenig - Wedbush Securities Inc., Research Division

Okay. So Q2 and Q3, the 2 biggest, but --

Mitchell K. Dauerman

Yes, 1, 2, it could go either way, and then it comes 4 and then 1.

Steven R. Koenig - Wedbush Securities Inc., Research Division

Okay. I guess along those lines, would you be -- you indicated how your model's not predicated on big deals. I'm curious though, would you be surprised to see big deals get signed in Q3?

Scott Scherr

No. No, no.

Steven R. Koenig - Wedbush Securities Inc., Research Division

Okay. All right. Last, my last one, which was intended to be the follow-up, can you tell me a little bit about, how do attrition rates from ADP and Ceridian, what -- folks from those vendors coming over to you, they're considering switching from an ADP or switching from a Ceridian, maybe to go to the other one, and then maybe Ulti can get in there, some of those deals. Or you're just -- you're pitching those customers when they're ready to leave those vendors and they're looking at any kind of alternative. How do those attrition rates and customers coming to you, tend to go -- in a tougher economic environment, do you find that customers are more apt to stick with those vendors or more apt to seek you out?

Scott Scherr

I mean, the only thing I can go back to is 2008, which we had a tremendous sales year in '08. I think it brought up. I think HR, after that, got taken to another level, along with payroll, especially with talent. And there's -- I think most companies are -- realize that it's really important how you hire people, how you onboard them, how you treat those people as you're going through and it's -- so I think there's a certain percentage of the market that is going to be looking in good times or bad times. And it's our job, everything we do is to try to find them, the people who are at least looking and then try and give us the opportunity to play. And when we get the opportunity to play in the right deal, I believe we're very hard to beat.

Operator

And now we'll go to Mark Marcon with R.W. Baird.

Mark S. Marcon - Robert W. Baird & Co. Incorporated, Research Division

Can you talk a little bit about what you're seeing in terms of implementation cycles as you continue to grow? Are they getting faster, slower? And I'm talking about for like-sized clients, relative to say, a year ago, 2 years ago.

Mitchell K. Dauerman

Mark, I'd probably say the same, relatively the same. Everyone's incented in the implementation team, to try to get customers live faster. But it's a team effort with the customer in going live. So even if we're ready to go faster, it really has to fit with the customers' desire.

Mark S. Marcon - Robert W. Baird & Co. Incorporated, Research Division

Sure, and then, can you talk a little bit about Workplace and what the average size of the deals are on the Workplace size? I obviously recognize that there's a targeted level, but wondering if they're going to the upper end, or the -- or if they're broadening out a little bit?

Scott Scherr

No, think it was north of 400, was the target. I think we're always trying to, just in general, we're always trying to increase the PEPM per deal, and we're always trying to increase the employee count per deal. It's within our expectations right now.

Mark S. Marcon - Robert W. Baird & Co. Incorporated, Research Division

Great. And then, the attach rates fluctuated a little bit, relative to last quarter. Is there anything that's occurring there? Or is it just the nature of the clients and what their needs were?

Mitchell K. Dauerman

No, I mean, it's exactly that. We looked at it, and we said, is there anything going on here, talk to the sales managers, talk to everyone. No, I think it's just, it just broke that way in the quarter. They were still good in our minds, but we've been having such high attach rates, it's just hard to keep up with that.

Mark S. Marcon - Robert W. Baird & Co. Incorporated, Research Division

Yes, and then, on the internal sales force, you mentioned that you're going to double it. What's that from and going to?

Mitchell K. Dauerman

Actually, I'm going from 9 to 23. I'm actually going to more than double it.

Mark S. Marcon - Robert W. Baird & Co. Incorporated, Research Division

And are you doing that, are they working both on the Enterprise and Workplace side, or...?

Mitchell K. Dauerman

Right now, we have people inside. In general, there are about 1 to 6, or 1 to 6. In -- on Enterprise, approximately 1 to 8, in Workplace, we're going 1 to 3. So we'll have 1 internal sales rep for every 3 quota-carrying salespeople. I think that will make a dramatic difference going forward in the opportunities we'll get.

Mark S. Marcon - Robert W. Baird & Co. Incorporated, Research Division

Great, and can you remind us -- the target was to get to 80 quota carriers for the year, is that still the idea, or is it...

Scott Scherr

Yes, there might be some there with the internal sales reps, I may go more management, I'm not sure. It will be somewhere between 76 and 80. Depending on how we decide to go, and we'll decide that in Q3 and we'll give you the exact numbers in Q3.

Operator

Our next question will come from Richard Baldry with Wunderlich.

Richard K. Baldry - Wunderlich Securities Inc., Research Division

Backing out the services number from Q3 and then also with Q4, it looks like you're more linear than normal.

Scott Scherr

It's more linear than normal?

Mitchell K. Dauerman

Rich, what are you saying is more linear?

Scott Scherr

Say it again.

Mitchell K. Dauerman

You back out the service number.

[Technical Difficulty]

Operator

And now we will take one more question, and that will come from Brian Schwartz with Oppenheimer.

Brian J. Schwartz - Oppenheimer & Co. Inc., Research Division

Mitch, one quick question for you. I wonder if you track the adoption rates within the customer base? Do you track the number of products that per customer, within you Enterprise and Workplace groups? I'm just wondering if you do, how that's been trending, and what type of opportunities go less organically here within the cost out [ph]?

Mitchell K. Dauerman

Brian, We don't -- I don't track it the way you're suggesting it. What we do have is a client base sales team that makes up, I don't know, probably 6% to 8% of our total bookings. The last several years, they filled quota every year, spending a lot of time on moving the customers from on-premise to hosting, but also at the same time, selling them additional product. When you look at our growth rate for the year, recurring revenue, we've said before, about 20% out of the 25 comes from selling new customers, 3 to 4 comes from selling back to the base, and then, 1% is the noise. So there's still an opportunity. But our growth rate is driven by new customers, especially since we have fairly high attach rates on the other modules. As we release new modules, we have a great opportunity to go back and sell those to a customer.

Operator

And that does conclude our question-and-answer session at this time. I'd now like to turn the call back over to Scott Scherr for any additional or closing remarks.

Scott Scherr

I appreciate all the interest and all the support out there and thanks for your time. I'm sure we'll be seeing you soon. Good night.

Operator

And that does conclude our conference for today. Thank you for your participation. You may now disconnect.

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Ultimate Software (ULTI): Q2 EPS of $0.34 beats by $0.04. Revenue of $80.8M (+25% Y/Y) misses by $16.37M. (PR)