Ultimate Software Group's CEO Discusses Q2 2011 Results - Earnings Call Transcript

Jul.26.11 | About: Ultimate Software (ULTI)

Ultimate Software Group (NASDAQ:ULTI)

Q2 2011 Earnings Call

July 26, 2011 5:00 pm ET

Executives

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

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

Analysts

Richard Davis - Canaccord Genuity

Laura Lederman - William Blair & Company L.L.C.

Sachin Jain - Kaufman Bros., L.P.

Patrick Walravens - JMP Securities LLC

Michael Huang - Needham & Company, LLC

Ilya Grozovsky - Morgan Joseph TriArtisan LLC

Brian Schwartz - ThinkEquity LLC

Nathan Schneiderman - Roth Capital Partners, LLC

Richard Baldry - First Albany Capital

Bradley Whitt - Gleacher & Company, Inc.

Matthew Coss - Piper Jaffray Companies

Mark Marcon - Robert W. Baird & Co. Incorporated

Operator

Hello, and welcome to Ultimate's Second Quarter 2011 Financial Results 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.

Mitchell Dauerman

Okay. Thank you, Marvin. 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 we'll be making other forward-looking statements regarding our current expectations of future events and the future financial performance of the company. These forward-looking statements are based upon information available to us as of today’s date and are subject to risks and uncertainties.

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

I'm going to begin by reviewing our financial results for the second quarter of 2011. 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 when comparing to the same period in the prior year. 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 second quarter of 2011, Ultimate reported recurring revenues of $52 million, representing 26% growth over the same quarter last year. Annualized customer retention exceeded 96% for our recurring revenue customer base. Operating income was $6.6 million and our operating margin was 10.3% for the quarter. Non-GAAP net income was $3.8 million or $0.14 per diluted share compared with $2.3 million or $0.09 per diluted share for the same quarter last year.

Our second quarter recurring revenues were $52 million and represent 81% of total revenues, compared with 76% for the second quarter of last year. The recurring revenue gross margin of 70.8% was in line with our expectations. Service revenues were $11.8 million, and in comparison to Q1 of this year, reflect the seasonality of W-2 revenues, which were included in Q1. The services gross margin reflects our overall business strategy as we have invested, and will continue to invest, in our Partners for Life program. License revenues were $400,000 for the quarter and were modestly ahead of our expectations, due to the employment-related growth of our on-premise customers. Operating expenses were $30.6 million for the quarter, in line with our expectations. Our operating margins for the second quarter are 10.3% compared with 7.2% last year, was due to the higher contribution from recurring SaaS revenues. Our non-GAAP income tax rate for the quarter was 41%.

Turning to the balance sheet. Total cash and investments and marketable securities were $54 million. On a year-to-date basis, we generated $15.2 million in cash from operations compared with $10 million for the same period last year. We invested $9 million in total capital expenditures on a year-to-date basis, compared to $3.8 million last year. As a reminder, these expenditures included the impact of moving into additional office facilities.

We used $7.9 million to acquire approximately 150,000 shares of our common stock during the quarter and for the year-to-date. We have approximately 255,000 shares remaining that are authorized in our buyback program. In addition, we used $1.2 million and $3.6 million for the quarter and the year-to-date period to repurchase shares required for settling employees' tax withholding obligations associated with the restricted stock units divested for the respective periods.

Accounts receivable increased to $46.7 million compared with $42.1 million at the end of June last year. DSOs were 66 days at the end of June 2011 compared to 70 days for the comparable period last year. However, deferred revenues were $73.2 million on June 30, compared with $61.5 million at June 30 last year. As a reminder, deferred revenues in the first half of the year reflects the seasonality in annual maintenance builds.

Long-term deferred revenues were $4.8 million on June 30, 2011, compared with $7.5 million for the same period last year, reflecting the elimination of one-time infrastructure fees in most of our new SaaS contracts as a result of the introduction of the Partners for Life program.

Turning to Q3 guidance. We expect recurring revenues will be approximately $54.5 million, and total revenues will be approximately $68 million. We expect operating margins to be approximately 12%.

Turning to our upcoming conference schedule, during the next quarter, I will be at the Morgan Keegan's Technology Conference on August 8 in New York, Oppenheimer's Tech Conference on August 10 and Canaccord Genuity's Growth Conference on August 11, both in Boston. Then on September 13, I will be at ThinkEquity's Conference in New York. And finally, on September 14, at the 2011 Deutsche Bank Texas Conference -- Tech Conference in Las Vegas. 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 everyone, for participating in our call this evening. We met or exceeded our 3 most important metrics: growth in recurring revenues, growth in our operating margin and customer retention. Our second quarter's recurring revenues were $52 million, up 26% over those of last year's Q2. Our operating margin was on the positive side of our target at 10.3%, and our customer retention rate was greater than 96%.

In Q2, our Enterprise sales team had the best performance in our history, and the average employee size of new customers was the largest we've ever had. Our Enterprise Talent Management attach rate remained strong at 60%, and we signed up the largest customer in our history in the quarter. A business with more than 85,000 employees has selected Onboarding, Recruitment, Performance Management and Time Management, in addition to Core UltiPro.

Some of our other new Enterprise SaaS customers in the quarter were: a retail chain with more than 13,000 employees have selected Onboarding, Recruitment and Salary Planning and Budgeting in addition to Core UltiPro; a restaurant chain with 13,000 employees that added Onboarding and Recruitment; a financial firm with 9,000 employees had chosen Recruitment, Performance Management, Salary Planning and Budgeting and Time Management; a high-profile appliance manufacturer with 8,500 employees; a leading provider of content management solution with 6,600 employees that added Onboarding, Recruitment, Performance Management, Salary Planning and Budgeting and Time Management; a healthcare company with 5,000 employees that selected Onboarding and Recruitment; and a Canadian-based airline with 5,000 employees, that added Salary Planning and Budgeting.

The trend of our on-premise customers electing to move to our SaaS model of UltiPro continued in Q2. We had 22 existing customers elect to convert from on-premise UltiPro to our SaaS model.

Turning now to Workplace. They, too, have the highest average employee size for new customers in Workplace's history. The percentages for our Workplace attach rates remain roughly the same as last quarter, except that Time Management shot up from 67% to 85%. The result was the highest PEPM per unit we've ever had in this space. The attach rates of our complementary products continue to be a good indicator of the market's appetite for an integrated payroll, human resources and Talent Management solution in both Workplace and Enterprise segments.

Some new Workplace customers in the quarter were: a transportation company with 900-plus employees that selected Recruitment, Performance Management, Salary Planning and Budgeting and Time Management in addition to the Core solution; a university publisher with 650 employees that also added Recruitment, Performance Management, Salary Planning and Budgeting and Time Management; a hospital with more than 700 employees that selected Recruitment and Time Management; a communications company with 700-plus employees that selected Recruitment, Performance Management, Salary Planning and Budgeting and Time Management; a recycling company with 700 employees that added Recruitment, Performance Management and Time Management; a bank with 725 employees that added Recruitment, Salary Planning and Budgeting and Time Management; and a wireless company with approximately 700 employees, that added Recruitment and Time Management.

I just came from our mid-year national sales meeting and enthusiasm, confidence and commitment are an all-time high after another record-breaking quarter in sales. Both our Enterprise and Workplace teams are excited about their success and the road ahead. They see that market demand for our products continues to grow, and we are well positioned to achieve both our 2011 and 2012 goals.

We are pleased to have a pipeline that continues to expand, and our marketing indicators continued in an upward trend. In Q2, we had 6% more respondents than in Q1 who said that they are looking to buy. At the American Payroll Association's show, we had 26% more leads than we did at ATA's 2010 show, even though the show itself had only a 3% increase in attendees over 2010. We also had an 18% increase in traffic to our company website in this year's Q2 versus Q2 of 2010, and more than 50% of the site traffic was new visitors.

In the area of activation, some of our new live Enterprise accounts in the second quarter were: Pep Boys, the leading automotive aftermarket service and retail chain in the United States with more than 18,000 employees in 630 locations; Northgate González Markets, a California supermarket chain with 4,500 employees; Kenko Management Services, a transportation and logistics company with 3,000 employees; Wente Family Estate, the well-known California winery; Groupon, a fast-growing online company that features a daily meal on the best things to do, see, eat and buy in 43 countries; and Calgary Stampede, a Canadian-headquartered non-profit with approximately 2,000 employees that preserves and promotes Western heritage through its world-renowned 10-day Stampede, year-round facilities and Western events.

Some of our activations in Workplace were: UV Logistics, the leading provider of land transportation and logistics for the energy sector; The Nuclear Energy Institute, a policy organization that participates in U.S. and global nuclear energy policymaking and recently worked on a joint leadership model to integrate the United States response to events at Japan's nuclear energy disaster; Tutor, Inc., an online educational partnership that offers degrees from high-profile universities globally. Tutor's Executive Vice President of HR said, "I have done 5 payroll implementations in my career and this one was, by far, the best." Intelligent Solution, a leading dental management and technology company. Intelligent is a good example of a company that moved from a service bureau to UltiPro to have access to a stronger, more strategic HR and talent management functionality. With UltiPro, Intelligent has already begun decentralizing routine HR administrative processes through self-service and workflow and has managed a doubling of its workforce's efficiency. Bankrate, Inc., a leading aggregator of financial rate information on the web. Bankrate is another customer that, like Intelligent, left the leading service bureau in order to find more strategic functionality and better service with Ultimate.

Our Partners for Life program continued to show gains in Q2 this year with a greater than 40% increase in customers trained over Q2 2010. There was a significant increase in the number of trainees from 5-plus-year customers from an average of 100 per month in 2010 to more than 350 per month for the first half of 2011. This is especially impressive since, historically, the first half of the year is typically lower in training attendance compared with the third and fourth quarters. Our Partners for Life program is doing what it was designed to do: make it easier for our customers to leverage a full scope of UltiPro's features and touch more users in our customers' organizations. The incremental benefit is that we enhance the quality of our customer relationships and encourage increased customer loyalty as well as the readiness to be a reference for us.

We strengthened our global initiative with the release of our new edition of UltiPro, this quarter, by giving our customers greater visibility into their global Workforce data and stronger global compensation management with new budgeting and forecasting features for their global employees. WriteInc., a leading marketer of home products with 2,500 employees, completed its first phase of its global UltiPro rollout. And they are now tracking employee metrics more accurately in 18 countries. With UltiPro, they have a single system of records for global compensation and job data. And many say that their analytical reporting is more accurate and they save huge amounts of time, compared with their previous method of consolidating hundreds of disparate spreadsheets.

SUBWAY World Headquarters is also experiencing significant business value and has gone live with UltiPro's Recruitment, Performance Management and Compensation for its global workforce. According to Lisa Shea, Assistant Director of Human Resources for SUBWAY, "We are already astonished at the amount of paper and the related cost that we have been able to reduce by automating talent management through UltiPro," and added, "We really just scratched the surface of UltiPro's value."

We finished the quarter 1,229 strong, and we are positioned well to achieve our goals for 2011 and beyond. We've come off the best sales quarter in our history. UltiPro is a human capital management product set for global businesses with sophisticated features and customer service support that is unmatched in the industry.

As a complete solution, UltiPro continues to get stronger. The attach rates of our complementary products and our marketing metrics reflect the market's increasing demand for UltiPro. Our customer retention rate is greater than 96%. And the positive feeling resulting from our Partners for Life program is resonating throughout our customer base. These are very exciting times for all of us.

We thank you for your continuing support. Let's go to the Q&A.

Question-and-Answer Session

Operator

[Operator Instructions] Our first question will come from Laura Lederman with William Blair.

Laura Lederman - William Blair & Company L.L.C.

When you are competing higher up for larger and larger customers, who do you run into the most? For example, in that client with 85,000 employees, what are the solutions that they're looking at? And I guess the related question is, your success in moving up market, what do you think has led to that? Or is it simply that you tried, and there's not the same competition that have the same problems as ADP that they have in smaller businesses? So they are happy as well and, therefore, are looking for a better solution?

Scott Scherr

We were up against a large ERP and a large service growth in that deal. I think its timing, we're getting into more large deals. And if we can get into the deal and we can run our process, we have a very good chance of closing the business. So I think it's a point in time for Ultimate. I think Workplace has pushed our Enterprise sales team higher. And I also think we're getting more opportunities because of who we are and who we've become at this point in time. I think we'll continue to keep getting more deals as we get into the process.

Laura Lederman - William Blair & Company L.L.C.

You used to say that at the high end, there weren't as many deals and they're sort of harder to win. What has really changed over the last 2 years that's led to more success in the high end or your -- is it, once again, the name brand? Is it -- what's changed your mind in the noncompeting high end in the market because you used to not really think that was a place for you to compete?

Scott Scherr

We've done well in the high end. I think just when you look at the numbers, how many companies in the United States with over 15,000 employees, I consider the high end over 15,000 employees. So I've always thought if we get the opportunity to compete in those areas that we would do well, which is what's happening.

Laura Lederman - William Blair & Company L.L.C.

Okay. How many customers are left, by the way, on the on-premise?

Scott Scherr

It's about -- I'm not sure of the exact amount, but it represents about 10% of our recurring revenue right now.

Laura Lederman - William Blair & Company L.L.C.

And has it gotten to a point where those are getting harder and harder to move because this quarter's success was interesting, the ability to move the ones you did. When do you get to the point where they're kind of unmovable? Or do you think you can get that other 10% within the next few years to move?

Scott Scherr

I think we can. It's actually getting easier and easier. Roadblocks are less and less as we move forward.

Laura Lederman - William Blair & Company L.L.C.

Is it because of the exceptions around demand or these maturities and solution-wise are getting easier?

Scott Scherr

I think it's -- SaaS and the acceptance of SaaS and they know -- they can't get our Talent Management products. They can't get our tax if they're on-premise. So we've been -- for us to be a good partner and for them to enjoy UltiPro, they really need to go to SaaS and we've been talking to them about that.

Operator

So our next question will come from Richard Davis with Canaccord.

Richard Davis - Canaccord Genuity

Kind of amplifying on what Laura said quickly. The -- do you get a sense, because one of the things that we get a sense talking to people is that -- especially if you go to the high end, some of the software that these folks are using is old, if not, ancient. And there's a -- this is a bit of an upgrade cycle. So if the feel, kind of in addition, that when you talk to these customers, they're like, look, we've been using this stuff for 8, 9 or 10 years. It's time for us to kind of step to the next level. And that ties in to your comments that SaaS is an accepted methodology by which to access the features and functionality you have. Is that a fair assessment? Am I getting that right?

Scott Scherr

I think it is. The large one that we did get, they wanted to go SaaS. So at the end, they wanted the SaaS solution. And if someone wants the SaaS solution in that space, and they want to integrate their payroll, HR, time, talent, we have a very, very good chance of winning that business.

Richard Davis - Canaccord Genuity

Got it. And then, there have been some people that have said that ADP is trying to do a better job. And you may or may not want to talk about any specific competitive vendors, but do you feel that some of these guys that -- let's say, historically, were not as good as -- and customer services have gotten a little friskier. But even if so, being nicer and friendlier may not be sufficient if you don't have the proper technology. Would that be the way you would describe it, or would you describe it in a different way?

Scott Scherr

I wouldn't describe it.

Richard Davis - Canaccord Genuity

It's like talking to the State Department. That's fine. I'm good on the question.

Operator

Our next question will come from Mark Marcon with Robert W. Baird.

Mark Marcon - Robert W. Baird & Co. Incorporated

I'm wondering if you can talk a little bit about the margin profile for the back-end of the year. The guidance basically implies that the operating margin is going to extend pretty dramatically in the fourth quarter relative to the third. Can you talk about the key drivers there?

Mitchell Dauerman

It's Mitch. Yes, I think we'll go through probably the 4 key drivers that we talk about every year when we talk about the leverage in the fourth quarter, which is also amplified this time by growth. First is, we typically have seasonal recurring revenue growth in the fourth quarter, and now we have more employees running in SaaS. Secondly, in the services area, services revenues are driven by the number of customers who are going to go live in January. We have the highest number of customers expected to go live in January ever. So that's going to drive more services revenue which precede it. We have a paid time off policy that calls for a 50% reduction of unused days at year end. So we normally have a credit to compensation for that elimination or reduction of the 50%, as compared to prior quarters, where we're normally increasing the expense. The amount is going to be higher this year because we have a greater -- a higher-margin labor force. The other item would be in Q3, we typically run 2 National Meetings, one for sales, which won't occur in Q4, so you have the expense in Q3 not in Q4; and then our services teams will meet for roughly a week. We won't not only have that expense in Q3 -- Q4 that we have in Q3, but also you have people who would be productive. You'll have an additional week of productivity in Q4 because they're not sitting in the meeting for the week. And then, the last item would be just the timing of discreet expenses. But I think if you look back to prior years, it typically is leveraged in between the third and fourth quarter and with the growth of the company, both in terms of employees and new sales, that leverage should be achieved.

Mark Marcon - Robert W. Baird & Co. Incorporated

Great. And I was wondering if you could talk just a little bit about -- on the services side, how should we think about those gross margins? Because I mean, obviously, the Partners for Life programs had a diminishing effect during the first half. But by the time we get to the fourth quarter, should that be close to where it was last year or even higher?

Mitchell Dauerman

Well, I think that for the year, our services gross margin probably end up around 5%. You know that services are not the driver of our business. We're very pleased with the success of Partners for Life and the decisions we've made there. The inference would be that there will be a stronger ramp-up in Q4 of the services gross margins in order to get to the 5%. And that's driven by the models we run based on the customers who are going live in January, as well as additional services that we typically sell to existing customers in the back half of the year.

Mark Marcon - Robert W. Baird & Co. Incorporated

Great. And then last question, can you just talk a little bit about the sales and marketing expense in this past quarter and how we should think about the increase that you experienced? There was relatively low increase relative to a year ago and a fairly significant drop off sequentially, but what drove that?

Mitchell Dauerman

Well, I think that when you look at the rest of the year, the sales and marketing expense stays relatively flat to drop off from Q1 is because -- probably because we have the National User Meeting in Q1, where we have a significant amount of investment in that project. As well as in Q1, you remember you had -- you're beginning your employment tax and other labor-related expenses that gradually go down each quarter.

Operator

Our next question comes from Ilya Grozovsky with Morgan Joseph.

Ilya Grozovsky - Morgan Joseph TriArtisan LLC

Just to follow-up on the services margins, is there any scenario under which you could have negative gross margins for the services business?

Mitchell Dauerman

I think that we could see flat, Ilya. As we've designed Partners for Life, we look at what services to include in the standard package. It makes the sales process better. There is less discussion about what's in, what's out. And it's a -- not to over say it, it's a small investment. The return is a significantly greater annuity.

Ilya Grozovsky - Morgan Joseph TriArtisan LLC

But so -- if I'm understanding correctly, you -- potentially, if you threw in enough stuff in there, you could end up with something pretty close to flat but not negative?

Mitchell Dauerman

That is correct.

Operator

And our next question comes from Richard Baldry with Signal Hill Capital.

Richard Baldry - First Albany Capital

Could you talk about the long term as you start to win more and more of these large-scale, tens and thousands of employee’s deals? Do you think you'll look to or want to strategically partner with some of the larger services companies' outsourced efforts around that, or that's one of the efforts inside the company you'd rather control and keep in-house?

Scott Scherr

I'd rather control it, although we do give about 10% of our services to outside companies to keep their hand in it. So we do have -- like the first half of this year, we do have places that we can get additional resources. Overall, we want to handle it ourselves.

Richard Baldry - First Albany Capital

And could we talk again a little bit about the implementation cycles on these larger-scale deals? You're a couple of quarters into the prior largest ever wins, and maybe you'll start to see how that is working? How those might change versus your typical deals in the mid-market or the smaller end of the market?

Scott Scherr

Well, I think you could say that the typical smaller end of the market is staying on track, maybe a little bit better. The Workplace deals we talked about before typically want to go on a calendar beginning. And the large deals are ones that have complexities to it that you work through the process. And they'll have their own type of life cycle, some that start out seeming to be a little longer go a little sooner. Some stay on track like the one you referred to in Q4 remains on track from what we've said before. It's still -- it's just doing the right thing.

Richard Baldry - First Albany Capital

And the last thing would be kind of how strong the Time Management attach rate was at 85%. Do you think you're seeing more replacement of point solutions? Typically, Time Management would be something -- someone would still have needed to address prior to implementing Ultimate. So maybe, are you placing more in that Time Management segment? I mean, what would the key drivers there be? And then maybe across other point solutions that you're encountering, do you think you're seeing a better sort of takeaway rate as if someone wants to go with a full suite solution?

Scott Scherr

Richard, we do. The bigger the percentage in Workplace that we get from the service bureaus, we almost have 100%, if they're using Time with the service bureaus, 100% attach rate on those. And then so that's what drove it up. There's so much business in the quarter from the service bureaus, so it drove up the Time Management percentage.

Operator

Our next question comes from Brian Schwartz with ThinkEquity.

Brian Schwartz - ThinkEquity LLC

Mitch, I was hoping to flesh out maybe a little bit on the revenue side, that big ramp in Q4. You did talk a little bit about the seasonality on the recurring revenue and the services revenue. Is there also maybe an expectation that this large 85,000 big deal could potentially go live in that quarter, which could help the revenue?

Mitchell Dauerman

No, no, no. Zero, yes.

Brian Schwartz - ThinkEquity LLC

Okay. So that won't be out. And then, Scott, you did mention in your commentary that Workplace set a new records for PEPM in the quarter. Is it possible to share with us what that new record ASP is?

Scott Scherr

Yes, it was -- it's north of 16.50.

Brian Schwartz - ThinkEquity LLC

Wow, fantastic. And last question I had here was just in the Partners for Life program, you guys had a couple of quarters now. Clearly, it's helping you guys on the retention side. Is it possible to talk a little bit on how that's helping you on the new deal activity, as well as possibly the cross-selling activity as you get more in front of these existing customers more frequently?

Scott Scherr

I think it's had a huge impact. My opinion is it's had a huge impact on sales. We rolled it out a year ago at our July mid-year meeting in Enterprise, and we've had record Q4, record Q1 and now record Q2. I think there's a direct correlation between that and the position we put ourselves in, in the market. I believe it's helped 100%. We've gotten more business, and we've gotten it faster because of Partners for Life.

Operator

Our next question comes from Mark Murphy with Piper Jaffray.

Matthew Coss - Piper Jaffray Companies

This is Matt Coss in for Mark Murphy. Mitch and Scott, could you guys talk about what kind of economic scenario you see or the economic scenario you're assuming for your guidance for the rest of this year? And then back a little bit on the services margin, how will signing these large customers affect that margin? Is it pretty material, or is it kind of still in line with your typical customer profile?

Mitchell Dauerman

Yes. I think that on the economic front, most people know that our growth comes from selling new business. So we really don't -- it's not a significant driver. Whatever we think, we typically model flattish, slightly up at this point. But nothing significant relevant to signing a new business and bringing them on board. As part of the impact of large customers on the services margins at this point, I think it probably is consistent with other deals.

Operator

Our next question comes from Nathan Schneiderman with Roth Capital.

Nathan Schneiderman - Roth Capital Partners, LLC

I have -- my first question is about your guidance for the 13% annual operating margin. And I just wanted to ask you how squishy or firm do you consider this number? For example, if you end up at 12.5%, is that approximately 13% to you? I'm just trying to understand your language and make sure I'm on the same page with you here.

Mitchell Dauerman

Nathan, we've always guided the same way. We're -- I think we share with everybody what our thoughts are that goes into the model. It's approximately 13%.

Nathan Schneiderman - Roth Capital Partners, LLC

Okay. And then, Scott, you made a few references to feeling like you have the capacity you need in place to not only deliver on this year's goals, but next. I was hoping you could share with us where you are in terms of number of reps with your Enterprise and Workplace? And does this mean you're not likely to do any sort of significant step function, other than sales force hiring, until in late 2012 or not?

Scott Scherr

Yes. We have 62 quota-carrying reps. We've been investing in marketing, and we've been investing in what we call inside sales that aren't quota carriers to get those 62 reps in some more opportunities. So as far as quota-carrying reps, we'll not be adding more to the 62 the first half of the year. So if we did add, it would be the second half of the year till 2013.

Nathan Schneiderman - Roth Capital Partners, LLC

Okay, got it. And then a question for you, Mitch, on services gross margin. I understand you're going to have a ramp in Q4. But for our models where we're projecting 2012, what's your current sense of where gross margin of services would likely normalize for 2012 and beyond?

Mitchell Dauerman

I think it's a hard question to answer. Right now if I was building my own model, I'd probably be keeping it flat with a 5%. We will give guidance after next quarter. And maybe whatever we guide to then would be what I would set going forward after 2012. Not to be repetitive, we just think about services as not the driver of the business. And we're in a great position with cash flow to invest in our customers, a great investment. And the trade-off is -- Scott talked about getting more customers, closing them faster, making them happier and increasing the annuity value of that customer. That's what I would do.

Operator

Our next question comes from Michael Huang with Needham & Company.

Michael Huang - Needham & Company, LLC

So a couple of quick ones. So, first of all, when you look at the attach rates for Talent Management in the Enterprise segment, is there anything that you're doing, either from a product innovation standpoint or from a go-to-market standpoint, that could help us move up over the next couple of years? Or is there a reason why the 60% represents the upper limit here?

Scott Scherr

I'm not sure. I think we're, obviously, happy with the 60%. I don't see why it couldn't move up over time.

Michael Huang - Needham & Company, LLC

I guess maybe you could clarify this from a product innovation standpoint. How is innovation budget being allocated across your product areas? And are there any product that you're singling out as getting the bulk of them?

Scott Scherr

No, I think it's overall. We have a Talent Management team. We have a Time Management team. We have a Core UltiPro team. We have a next-generation team. So it's across all areas. So we listen to the market. We listen to our clients, and that's what we've always done, and it's worked. So I think the PEPM could definitely go up because, over time, we're enhancing the products we have. We're going deeper with the products based on what our clients tell us. And we're going to -- we're adding new ones down the road.

Michael Huang - Needham & Company, LLC

Great. And then, Mitch, could you talk about -- I think you had mentioned that you saw some pretty unusual, from a seasonality standpoint, training growth in terms of attendees in the first half. So in the second half, are you expecting or assuming that training growth would be kind of higher from a year-on-year standpoint just given difficult seasonality, or maybe if you could just walk us through kind of what your assumptions around training growth for the second half of the year?

Mitchell Dauerman

Well, the comment that Scott made in his comments talked about the increased attendance of customers, especially longer-term customers. I'm on the training since we eliminated the cost of attending. So there is no revenue in the model for that. But I think the significance is, we've seen that uptick. We expect it to increase, and we believe that the more customers that attend and the more reach we get within the organization, the stronger the customer will be, both in terms of being happy using the product fully and becoming a good reference for us.

Michael Huang - Needham & Company, LLC

Okay. In terms of kind of the service infrastructure or the training infrastructure and the capacity that you have and you can support a step-up in terms of attendee, kind of attendee year-over-year growth in the second half of the year?

Mitchell Dauerman

They were -- since some of the training is done over the web, there could be some incremental costs associated with it. It would be a good investment.

Operator

And our next question comes from Patrick Walravens with JMP Securities.

Patrick Walravens - JMP Securities LLC

I'm Patrick Walravens. I had a question on the margins in the second half. But I think most have been answered already. So, just quick question, what kind of trends are you seeing in your same-store sales growth rates?

Mitchell Dauerman

I'm sorry, did you say same-store?

Patrick Walravens - JMP Securities LLC

Same store sales, yes.

Mitchell Dauerman

Yes. No, I would say that -- again, we don't give specific numbers on that, but they have been up.

Operator

Our next question comes from Sachin Jain with Kaufman Bros.

Sachin Jain - Kaufman Bros., L.P.

A couple of quick questions. I closed a question on competition. Recently, NetSuite and Ceridian signed a partnership offering payroll solutions. Any thoughts on how such tie-ups between service bureaus and on-demand players could impact Ultimate?

Scott Scherr

Well, as of yet, it has no impact. And as far as I know, that was a tax filing deal that they did. So they were providing tax filing for NetSuite's lower-end clients. We don't see NetSuite in our market at all, 0.

Sachin Jain - Kaufman Bros., L.P.

Got it. And second, then, also what do you think are going to be the biggest levers for margin expansion, let's say, over the next 2 to 3 years? Specifically, how should we be thinking about sales expansion as a percentage of revenue of net sales over the next 2 to 3 years?

Mitchell Dauerman

Well, the biggest lever in our operating margin expansion is recurring revenue as it becomes a larger percentage of total. And it carries a higher gross margin. Secondly is the management of operating expenses, which we've said, our goal is to manage those operating expenses at roughly 1/2 of the recurring revenue growth rate.

Sachin Jain - Kaufman Bros., L.P.

And do you also think like as the average size of the customer is increasing, that could also impact your profitability in a positive manner?

Mitchell Dauerman

It could, yes.

Operator

And for our last question, we'll go to Brad Whitt with Gleacher.

Bradley Whitt - Gleacher & Company, Inc.

A couple of things. Doing a follow-up. Nathan had asked you about gross margins for services looking out to 2012. Just going back to your gross margin for your recurring revenue, 70.8%, I think that's the lowest I have in my model for several years. Can you just comment on whether or not you're seeing pressure there on your recurring revenue margins? And then, how should we think about that as we look out to 2012?

Mitchell Dauerman

Well, I think as we've talked about, for probably a number of quarters, we are making -- we've made investments in the recurring revenue business, particularly tax filing. I think, if you go back to the transcript, probably for Q4, you'll hear that discussion. So the expectations here was to stay relatively flat. So it's making investments. Going forward, we'll give guidance for 2012 on the next call or preliminary. My thought right now is it should go up about 75 to 100 basis points.

Bradley Whitt - Gleacher & Company, Inc.

That's helpful. You mentioned the tax filing. It's my understanding that your partner for tax filing was acquired by ADP? Are there any thoughts about changing your partnership there?

Scott Scherr

No. It's a small piece of it, and it's been going great. And it's been a great relationship with that company, and it still is a great relationship.

Bradley Whitt - Gleacher & Company, Inc.

Okay. I guess another question I would have would be -- was there -- you say that service is not a driver of your business, but it sounds like maybe free services is helping to -- you to attain new customers faster. Would that be correct?

Scott Scherr

I think it's the whole Partners for Life, the combination of fix the implementation, training for life and, as Mitch said, taking away the one time upfront. Those 3 areas, I think, certainly are helping sales.

Operator

And this concludes today's question-and-answer session. I would like to turn the conference back to Mr. Dauerman for any closing or additional remarks.

Scott Scherr

Well, this is Scott. Mitchell doesn't want to say anything. But thanks for all your support. I look forward to next quarter. Take care.

Operator

This concludes today's conference. Thank you for your participation.

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