The Ultimate Software Group (ULTI) Q3 2018 Results - Earnings Call Transcript

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About: Ultimate Software Group, Inc. (The) (ULTI)
by: SA Transcripts

The Ultimate Software Group, Inc. (NASDAQ:ULTI) Q3 2018 Earnings Call October 30, 2018 5:00 PM ET

Executives

Felicia Alvaro - The Ultimate Software Group, Inc.

Scott S. Scherr - The Ultimate Software Group, Inc.

Analysts

Scott Berg - Needham & Co. LLC

Justin A. Furby - William Blair & Co. LLC

Richard K. Baldry - ROTH Capital Partners LLC

Mark R. Murphy - JPMorgan Securities LLC

Brad Alan Zelnick - Credit Suisse Securities (NYSE:USA) LLC

Samad Samana - Jefferies

Joe Goodwin - JMP Securities LLC

Alex Sklar - Raymond James & Associates, Inc.

Steve R. Koenig - Wedbush Securities, Inc.

Peter Levine - Evercore Group LLC

Mark S. Marcon - Robert W. Baird & Co., Inc.

Operator

Hello, and welcome to Ultimate's Third Quarter Financial Results 2018 Conference Call. At this time, all participants are in a listen only mode. Today's conference is being recorded.

Your presenters today will be Mr. Scott Scherr, Chief Executive Officer, President, and Founder of Ultimate, and Felicia Alvaro, Chief Financial Officer. We'll begin with comments from Felicia Alvaro.

Felicia Alvaro - The Ultimate Software Group, Inc.

Thank you, Justin. 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.

Please 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. 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 differences between GAAP and non-GAAP financial information are non-cash stock-based compensation, transaction costs related to business combinations, and the amortizations of acquired intangible assets.

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. I'm going to begin by reviewing our Q3 financial results, and then we'll provide guidance for the fourth quarter of this year, and preliminary guidance for 2019. As we are in the process of fully integrating both the operations and the financial results of our recent acquisition of PeopleDoc into that of Ultimate, I will be reporting our Q3 financial results on a consolidated basis, which will also be the case for our 2019 preliminary guidance.

However, for Q3 and the rest of 2018, to enhance comparability with last year, I will discuss the impact of PeopleDoc for certain key items. For the quarter, recurring revenues grew by 25.4% to $254.5 million. PeopleDoc accounted for 250 basis points of that recurring revenue growth. Total revenues grew 21.9% to $287.8 million for the quarter. PeopleDoc accounted for 240 basis points of that total revenues growth. Recurring revenues on an organic basis were slightly better than we expected, including the impact of favorable improvements against modeling assumptions around employment, and some deals that went live earlier than projected.

Our recurring revenues gross margin was 73.7%, which was slightly below our expectations and included the impact of certain one-time expenses that were incurred in the quarter. Revenue retention from our cloud customers was as expected, approximately 96%. Total revenues of $287.8 million were also in line with our expectations. The total gross margin rate was 63.4%.

Our total expenses, which are made up of our cost of revenues and operating expenses, were $230.1 million for the quarter, and were slightly less than we expected. Operating income was $57.7 million, and the operating margin was 20.1%, which was ahead of our expectations for the quarter, mostly as a result of the lower total costs. Our operating margin computed on a basis of expensing the capitalized R&D costs, with the related product amortization added back, or as expensed, was 17%, and was also ahead of our expectations due to our lower cost. The inclusion of PeopleDoc for the two out of three months of the quarter, post-acquisition, reduced both our as reported and as expensed non-GAAP operating margins by approximately 100 basis points. Our non-GAAP income tax rate for the quarter was 28%. Net income was $42.4 million, and the related diluted net earnings per share were $1.33.

Turning to the balance sheet, our cash and marketable securities balance was $141 million, and reflect a total of $55.7 million used for shares acquired to settle employees' tax withholding liabilities associated with their restricted stock that vested. The average daily float balance for our payment services business was approximately $1.3 billion for the nine-month period. Operating cash flows for the nine-month period grew 24% to $172.2 million, as compared with $139.3 million for the same period of last year.

For comparability purposes in the free cash flows discussion, and excluding the impact of the $74.4 million paid in cash at closing for the PeopleDoc acquisition. Free cash flows for the 2018 year-to-date period were $113 million, as compared with $77.3 million in 2017. Our free cash flow margin was 13.5% for the nine-month period, through Q3 2018, as compared with 11.2% for last year's same period.

As a reminder, we bill on a quarterly basis, as opposed to annually. As mentioned last quarter, if we billed on the more typical annual basis, we believe our free cash flow margin would be between 10 and 15 percentage points higher. Our capital expenditures for the nine-month period were $59.2 million, including capitalized R&D costs of approximately $37.1 million. This compares with 2017 year-to-date CapEx of $62 million, which also included $37.1 million of capitalized R&D costs.

Next, I'd like to discuss our financial guidance. We expect our financial goals for 2018 to be as follows: grow recurring revenues by approximately 24% over 2017, inclusive of PeopleDoc, which is expected to contribute approximately 100 basis points of that growth; grow total revenues by approximately 21% over 2017, inclusive of PeopleDoc, which is expected to contribute approximately 100 basis points of that growth; and, achieve an operating margin of approximately 21%, inclusive of PeopleDoc, which is expected to have an approximate 100 basis point reduction to our operating margin. This full-year guidance reflects an increase in our recurring revenues' expected growth, which has been revised since last quarter.

For Q4 of this year, we expect recurring revenues to range between $262 million and $264 million, total revenues to be approximately $300 million, and the operating margin to be approximately 21%.

We have been as transparent as possible in isolating the impact of the PeopleDoc acquisition on our financial results for this year. However, because PeopleDoc will be integrated into our numbers, particularly from an operational and financial perspective, after this year we are unable to segregate the impact it will have on future financial results.

For 2019, our preliminary guidance is to grow recurring revenues in excess of 21% and total revenues by approximately 20%. We have roughly 94% visibility into our 2019 recurring revenues target, which assumes no new sales prospectively. We expect our operating margins to be approximately 20%. We are also expecting our as expensed operating margins to be approximately 17%. Our 2019 guidance includes the impact of the PeopleDoc acquisition and, therefore, includes a combination of the full-year operating results of PeopleDoc, as well as expected integration costs as it is folded into our Ultimate global operations.

We are expecting the PeopleDoc acquisition and related integration costs will produce approximately a 200 basis point headwind in 2019, based on our estimations. We plan to continue investing in the infrastructure of our business to support our international growth, and we believe our investment will create the right foundation to achieve our longer term goals, which Scott will discuss.

Our non-GAAP tax rate for 2018 should be approximately 28%, and diluted weighted average shares should be approximately $32 million. We expect capitalized R&D cost to be around $50 million, plus or minus 5%, in 2019. Our capital expenditures, including those related to increase leased space to accommodate our continued growth, including international expansion in 2019, are expected to be approximately $60 million to $65 million.

We expect depreciation and amortization to be approximately $67 million, including more than $12 million related to capitalized R&D cost. We will provide additional guidance on quarterly trends on our February 2019 call along with our final 2019 guidance. However, we want to remind you that our Q1 operating margin rate is typically lower than that of our Q4 rate.

Turning to our upcoming conference schedule, during the next quarter, Mitch will be in the Scottsdale, Arizona on November 28 for the Credit Suisse TMT Conference, and in Park City on December 4 for the Wells Fargo Tech Summit, and December 6 for the ROTH Capital Corporate Access Event. If you are available at those conferences to meet, please let Mitch know.

Now, I'll turn the call over to Scott.

Scott S. Scherr - The Ultimate Software Group, Inc.

Thank you, Felicia, and thank you, everyone, for participating in our call this evening. Our year-to-date results guarantee that we'll achieve our 2018 objectives and Q3's performance laid the groundwork for a successful 2019. Recurring revenues were above expectations of more than 25% versus 2017's Q3 to approximately $255 million on a consolidated basis including PeopleDoc revenues. Total revenues were consistent with the high side of our guidance at $288 million, up over Q3 2017 by approximately 22%, our non-GAAP operating margin was on target, just a hair over 20%, and our customer retention rate was, once again, approximately 96% on a year-over-year basis. We are pleased to have PeopleDoc now as an integral part of our ULTI family. Their talent, experience and infrastructure in Global HR Services Delivery are a perfect fit for the value proposition we offer our customers and their culture aligns seamlessly with ours. We are calling this division International Sales.

Last week, I met our salespeople in Las Vegas and they're excited about their achievements and wrapping up the year in record fashion. They've generated serious momentum and they're inspired by the results they see our customers enjoying with UltiPro. The Chief Human Resources Officer of our Customer Telecare, Suzanne Rudnitzki, for example, recently said that in the year after launching UltiPro Onboarding, Telecare's 90 day turnover rate dropped by 50% and the combination of UltiPro Recruiting and Onboarding together saved them more than $750,000 while at the same time helped them find and retain the best local talent in healthcare. She gave UltiPro credit for enabling Telecare to communicate their branding and identity to prospective medical hires effectively and giving them a new found significant edge in the highly competitive healthcare industry where there are now severe shortages of licensed staff.

Looking at our enterprise team's attach rates for new customers in the third quarter, Recruiting 85%, Time Management 78%, Performance Management 63%, plus our enterprise team had a 100% attach rate for Onboarding. Some of our new enterprise customers were a publicly traded television broadcasting company with 8,500 employees that added recruiting Onboarding, Time and Scheduling to core UltiPro, a gaming and casino enterprise with 7,800 employees that added Recruiting, Onboarding, Time Management, Performance, Comp, and Succession Management plus two of our newer solutions Learning and Benefits Prime. The healthcare company with 6,000 employees that added Onboarding, Time Management, Scheduling and Benefits Prime and an aerospace company with 5,000 employees that added Recruiting, Onboarding, Time Management, Performance, Comp, Succession, plus all three of our newer solutions, Learning, Perception and Benefits Prime.

Our mid-market strategic team's attach rates were Onboarding 97%, Time Management 83%, Recruiting 78%, and Performance 78%. Some new mid-market customers in the quarter were a leader in polymer manufactured products with 2,500 employees that added Recruiting, Onboarding and Time. A background screening company with more than 2,000 employees added Recruiting, Onboarding, Time, Scheduling, Performance, Comp, and Succession Management as well as our new learning solution, an aerosol manufacturer with more than 1,700 employees that added Recruiting, Onboarding, Time, Performance, and Comp Management and a wine and spirits importer also with more than 1,700 employees that added Recruiting, Onboarding, Time, Performance, Comp as well as Learning and Benefits Prime. A couple of our new strategic customers in the quarter were an online automobile wholesaler with 500-plus employees added all of our key add-on solutions, Recruiting, Onboarding, Time, Performance, Comp and Succession. In a healthcare organization with 500 employees that also added all of our key add-on solutions plus UltiPro Perception.

Our International Sales team had a strong quarter. The northern Europe team had its best quarter in the history of PeopleDoc and closed a transport and logistics services organization with 17,500 employees. Central Europe also did very well closing a manufacturer with more than 5,000 employees and one of the largest banks in Germany with 45,000 employees serving more than 18 million customers while financing approximately 30% of Germany's foreign trade. PeopleDoc will make it easy for all the worldwide employees of these companies to get HR help independent of time, location, or device.

Demand for UltiPro solutions remains strong. Q3 2018 was the second strongest quarter in our history for looking responders, that is people from organizations with 300 or more employees who say they are looking to purchase a new HCM solution in 12 months or less. On a comparative basis, it was a 24% increase over Q3 2017. Q3 this year was the best third quarter ever for unique visitors to our company website. We had a 43% increase in the number of attendees to our HR workshops held across the country in Q3 2018 versus the same quarter 2017. And for seminars conducted by our salespeople, we had a 225% increase in a number of leads generated for the quarter year-over-year.

During the third quarter, we finalized a strategic alliance with Deloitte Canada, one of Canada's leading professional services firms. This collaboration will enable enterprise companies throughout North America to optimize UltiPro through Deloitte's business transformation and technology capabilities. Deloitte's consulting services will help Ultimate customers maximize organizational performance by creating standardized methodologies around our employee experience. Our partnership strategy was formed with the objective to share with HR advisory firms throughout North America, how Ultimate can best benefit perspective clients through our UltiPro solutions.

Over the last five years, our partnership ecosystem has seen significant growth increasing from 4 to 43 certified service partners. We have built our partner relationships on trust and transparency, just as we have with our customers and employees, ensuring that the ecosystem is built to last. Our strong bonds with HR consultants in our ecosystem have enabled us to have our valuable clients activated by trusted partners and at the same time allowed us to increase our recurring revenues as a percentage of total revenues to approximately 90%.

Today Fortune Magazine recognized Ultimate as the Number 1 on its 2018 100 Best Workplaces for Women list. The rankings were determined in coordination with Great Place to Work and based on its analysis of hundreds of companies' practices and data as well as on surveys completed by 540,000 employees across the nation. Our Chief People Officer says it best; Ultimate recognizes the pivotal role women play every day as people and professionals and how their pioneering work and achievements have impacted our lives throughout history. When we started Ultimate 28 years ago, there were four of us, including two women. Together, we set out to foster and protect a culture that cared for and respected all people while providing opportunities for continued growth and innovation. Today, we're more than 5,000 strong, committed to building the best HR technology and serving our colleagues, customers, and communities across the globe.

Ultimate received other third-party recognition that we are proud of in the third quarter. Gartner named Ultimate a leader in its 2018 Magic Quadrant for HCM Suites (sic) [Cloud HCM Suites], for both mid-market and larger enterprises, based on its criteria for ability to execute and completeness of vision. Nucleus Research recognized Ultimate as a leader in its HCM Value Matrix for the sixth consecutive year. Ultimate earned the top rating for product functionality, and was one of the two highest vendors for usability. Our AI platform, Xander, was selected by Human Resource Executive Magazine as one of the Top HR Products of 2018. The winners were selected based on the product's level of innovation, its value to the HR function, how intuitive it is for a user, and whether the product delivers on its promises. People Magazine ranked Ultimate number three on its 2018 Companies That Care list. Ultimate was also named to Canada's 2018 list of Best Workplaces in Technology, and AnitaB.org's 2018 Top Companies for Women Technologists.

At the close of the third quarter, we were 4,842 strong. We are looking forward to becoming a $1 billion franchise this year. We now support more than 40 million people records in Ultimate's cloud environment, and we continue to lead the HR cloud industry in numbers of customers using a unified HCM with human resources, payroll, talent, compensation, and time and labor management. We have completed the acquisition of PeopleDoc to extend our global reach, and offer a comprehensive HR services solution that greatly enhances the employee experience with person-centric features, like an online employee help center, HR case management, and employee file management. The confidence that our sales organization has in our future, along with the added enthusiasm and assurance from our new PeopleDoc organization, gives us confidence that we will now reach $2 billion in total revenues by 2021. That will be our sixth championship. We'll reach that goal by doing what we have done for 28 years. We'll continue to make the product better, make our services better, and we will stick together, always putting our people first. This is our 83rd conference call. We want to thank all of you for taking this journey with us, and look forward to your continuing support.

Let's go to the Q&A.

Question-and-Answer Session

Operator

Well, thank you. Our first question today comes from Scott Berg with Needham.

Scott Berg - Needham & Co. LLC

Hey, Scott and Felicia, thanks for taking my questions today. I guess my first question, Scott, is – after you've had the PeopleDoc acquisition for three months now, is do you have any updated thoughts on how that product will impact your sales pipelines and your opportunities going forward?.

Scott S. Scherr - The Ultimate Software Group, Inc.

Well, I think it's going to be positive. We've decided to stand up a standalone PeopleDoc team in North America. I mean, they've had people there, but we're going to invest in that and have them sell standalone along with Perception and other products. They're working great with our strategic account managers here, so – and obviously, in Europe we have – everything there's going to be just a total plus to what we have here, but it's been exceptionally good so far, and it's what gave me the confidence to move fully into 2021.

Scott Berg - Needham & Co. LLC

Got it, helpful. And then, a question on the competitive environment in the customer segment, say, that's 1,000 to 5,000 customers. I ask question because Paycom apparently, today, announced that they're moving up into the market more en masse for the first time. Are you guys seeing anything different in that segment, whether it's around win rates or maybe how customers are buying solutions there? And I guess, what gives you the confidence to continue your strong win rates that you've had there for several years?

Scott S. Scherr - The Ultimate Software Group, Inc.

I haven't seen anything different. I mean, my confidence is in the sales team. It's in our past. It's in our performance. It's in our less than 10 – our 90-plus percent retention in the sales organization, in our products, in our services, in our culture. I'm more confident than I've ever been, quite frankly.

Scott Berg - Needham & Co. LLC

Excellent, thanks for taking my questions.

Operator

And next will be Justin Furby with William & Blair Company.

Justin A. Furby - William Blair & Co. LLC

Hey, guys, thanks and congrats on the quarter. Scott, I guess I just want to follow up on the revenue target, the $2 billion number. You obviously have a great track record with these. And just feel like maybe one of your bolder targets, I think, it implies 21% or higher revenue growth in 2020 and 2021 which is actually a little bit faster than your guidance for next year. And the numbers are starting to get pretty big at this point. I'm just wondering how you'd sort of describe the confidence around that timeframe and that target versus some of these other championships you've set out in the past. And can you do it organically, do you need to acquire things along the way and any sort of framework for sort of the sales rep growth in getting that $2 billion would be helpful. Thanks.

Scott S. Scherr - The Ultimate Software Group, Inc.

Well, I think organically now with PeopleDoc part of us, I believe we could get there. I believe that International Sales when we get there will account for over 5% of our business. So I think that – we were going to be close to it before, in 2021, it just – so I thought I was maybe being a little conservative because our numbers didn't say where we were going to get there. But once we looked at the numbers of PeopleDoc and got the confidence in the International Sales organization and the team that were standing up in North America, and based on what we're going to quote in next year, I think – yeah, I think it's very attainable. Obviously like the five championships we've had, you have to execute on more. But we're five for five, and I bet even money or more of that we're going to be six for six.

Justin A. Furby - William Blair & Co. LLC

Got it, that's helpful. And then maybe just quickly for you, Felicia, on services revenue. In this quarter and for Q4 guidance, it was a little bit lower than where we were. Is there anything to call out around that for the back half of this year? Thanks.

Felicia Alvaro - The Ultimate Software Group, Inc.

Sure. Actually, our services full year are pretty much in line with what we originally expected. It does include a little bit of PeopleDoc, but one of the things that it also includes is we're starting to see the impact of moving some of our business off our papers. So we do have that and we have some additional costs in the back half, particularly in Q4 that you wouldn't have seen entirely before for things that were added toward the end of last year with regards to some of our consultant cost.

Justin A. Furby - William Blair & Co. LLC

Got it, thanks very much.

Felicia Alvaro - The Ultimate Software Group, Inc.

Okay.

Scott S. Scherr - The Ultimate Software Group, Inc.

Thanks, Justin.

Operator

Next will be Rich Baldry with ROTH Capital.

Richard K. Baldry - ROTH Capital Partners LLC

Can you talk about how the standalone team for PeopleDoc in North America will work with your existing reps? Will it be sort of lead generation type of thing, hand offs like that, sort of curious how that will work? Thanks.

Scott S. Scherr - The Ultimate Software Group, Inc.

Yeah, they'll have their own book of business to go after. They'll work in concert with the team, but they'll be in concert with – if they can get into an opportunity and they want payroll or the other HR products that we have, they would be lead generator to our people. But they'll be selling standalone in North America with companies over 2,500 employees. And, yeah, they've been doing that and they've been successful doing that, and we're going to grow that.

Richard K. Baldry - ROTH Capital Partners LLC

And then looking longer term, you still stated this 96% retention rate. If you think about adding PeopleDoc which is a bit of a different services oriented business, the strength you're having in the under 1,500 employee space, do you think that's still a good goal, either long intermediate term or do you think just sort of the nature of the business will pull that down slowly over time? Thanks.

Scott S. Scherr - The Ultimate Software Group, Inc.

Yeah, well, just so one of the things we loved about PeopleDoc was their retention rate was 100%. So, yeah, I mean, I think 97% will be a better goal, but I think we can maintain 96%.

Richard K. Baldry - ROTH Capital Partners LLC

Great. Thanks.

Operator

Moving on to Mark Murphy with JPMorgan.

Mark R. Murphy - JPMorgan Securities LLC

Yeah, thank you, and I'll add my congrats. So Felicia, does the $3 billion target move forward a year in unison with the $2 billion target or do you think we're better off keeping that out at 2025 since that is still pretty far off on the horizon for you?

Scott S. Scherr - The Ultimate Software Group, Inc.

I'd leave it off when we...

Felicia Alvaro - The Ultimate Software Group, Inc.

Yeah. I think...

Scott S. Scherr - The Ultimate Software Group, Inc.

When we get close, like we've always done, we'll adjust it. Right now everyone here already is focused on, attaining our sixth championship and hitting that number $2 billion in 2021. I think if we come out of that with a momentum like I hope we do and I believe we would, then, yeah, obviously would move up. But we'll tell you...

Mark R. Murphy - JPMorgan Securities LLC

Okay.

Felicia Alvaro - The Ultimate Software Group, Inc.

Yeah.

Mark R. Murphy - JPMorgan Securities LLC

All right, yeah, appreciate it. I was wondering as well if you could, Scott, maybe comment on, or Felicia on your services capacity to get deployments live just relative to the pace of the new bookings, which seems to be pretty healthy. I noticed you had said in the script that some of the deals went live earlier than expected. I think at the same time, there's a couple of people of ecosystem that think that there's not a lot of slack there or it's a little bit stretched, so just what is your overall assessment of your go-live capabilities currently?

Felicia Alvaro - The Ultimate Software Group, Inc.

First of all, when talking about the early go-lives, they really just pull forward one quarter. We do look at our current and our expected future time to live which would include what the service team could deliver, and they're pretty much in line with what we have now. So in terms of our ability to service the sales as they occur, I believe we're in the same shape as we always have and we'll be able to do that.

Mark R. Murphy - JPMorgan Securities LLC

Okay.

Scott S. Scherr - The Ultimate Software Group, Inc.

Yeah, I've heard some of those things, and I checked and there's just nothing out of the norm here. Obviously there's always a seasonal workload. We had a monster Q2, but getting more and more partners involved, it's up to about kind of like 20% now partners involved and growing. But yeah, I heard that too, and I just tell you that I talked to Julie, our Chief Services Officer, and just nothing out of the norm. And we feel we're in good shape.

Felicia Alvaro - The Ultimate Software Group, Inc.

Right, we use our consultants and we leverage with the partners, which as Scott said, I mean, we're roughly around 20% and expected to maintain that position.

Mark R. Murphy - JPMorgan Securities LLC

Okay. Great to hear that. One last quick one. Scott, if I understood what you're saying, I think you said PeopleDoc closed the European bank with over 45,000 employees which is an interesting headline. Just any sense of the relative size of a transaction like that for PeopleDoc compared to if you close 45,000 employees as a payroll or HCM deal?

Scott S. Scherr - The Ultimate Software Group, Inc.

Yeah, it's hard to give, but it would have been a really nice – would have been equivalent to about a 5,000 employee all-in HR payroll deal with high attach rates with everything else.

Mark R. Murphy - JPMorgan Securities LLC

Wow.

Scott S. Scherr - The Ultimate Software Group, Inc.

Equivalent – did you get equivalent to a 5,000 all-in, high attach rates, payroll and everything else here. So a really good deal.

Mark R. Murphy - JPMorgan Securities LLC

Yeah, okay, that's impressive, that's impressive. Thank you very much.

Scott S. Scherr - The Ultimate Software Group, Inc.

Thank you.

Felicia Alvaro - The Ultimate Software Group, Inc.

Thanks.

Operator

And next is Brad Zelnick with Credit Suisse.

Brad Alan Zelnick - Credit Suisse Securities (USA) LLC

Thanks very much. Scott, you mentioned the award that you won for Xander in the quarter and now it's been in the market for a while. I was hoping you could talk a little bit about the use cases and adoption and differentiation you're seeing out there and how pervasive you think it can ultimately become.

Scott S. Scherr - The Ultimate Software Group, Inc.

Well, it's in the Perception product right now and I think our attach rates on that are about 25%, but I believe it's going to be pervasive throughout the whole product line. It's going to be in our new Performance module that's going to be a standalone and an integrated module going forward and anything we do in the product in the future is going to have Xander as part of it. So I think it's our future.

Brad Alan Zelnick - Credit Suisse Securities (USA) LLC

Awesome. And Felicia, if I could just ask, how much of the strength in recurring revenue is driven by new logos versus better attach this quarter? And how should we think about the trend there? Thank you.

Scott S. Scherr - The Ultimate Software Group, Inc.

It's always new logos. About 90% of our bookings are new logos; about 10% comes from our client base. Our attach rates have been always high, consistently, so you know, we run on new units and that's how we grow.

Brad Alan Zelnick - Credit Suisse Securities (USA) LLC

Okay. Thank you.

Felicia Alvaro - The Ultimate Software Group, Inc.

Thanks.

Operator

And next will be Samad Samana with Jefferies.

Samad Samana - Jefferies

Hi, thanks for taking my question. Felicia, if I could, just on the margin guidance for the initial outlook for 2019, could you give us an idea of how much of an impact PeopleDoc had, and what the core business' margin would have looked like if you hadn't acquired PeopleDoc next year in terms of margin expansion?

Felicia Alvaro - The Ultimate Software Group, Inc.

I can tell you that we're at the point of estimation, now, because as I mentioned at the beginning of my script, we are incorporating PeopleDoc into our operations, both from a financial as well as an operational perspective; so, it would be a pure guess at this point. As mentioned, they are expected to have a 200 basis point headwind impact on us next year on our bottom line. I would say that their composition is similar to ours, and we're looking more in terms of their bottom line impact for next year as opposed to their impact on our gross margin.

Samad Samana - Jefferies

Got you. Maybe just as a follow up to that, what would you have forecasted for Ultimate's standalone business if not for the acquisition for 2019; maybe 50 basis points, 100 basis points? I'm just trying to understand what the expansion (36:38).

Felicia Alvaro - The Ultimate Software Group, Inc.

Okay, sure. We would have expected that, if you back out the 200 basis point, we would have grown our operating margin – in an as expense basis as well as an as reported basis. So yeah, we would have seen some expansion close to 50 basis points next year – around; a little bit more.

Samad Samana - Jefferies

Great. That's helpful.

Felicia Alvaro - The Ultimate Software Group, Inc.

It's a guesstimate, at this point, because like I mentioned, organic, right now, is hard to break out.

Operator

And moving on to Pat Walravens with JMP Securities.

Joe Goodwin - JMP Securities LLC

Hi, this is Joe Goodwin on for Pat. Just a quick question around how you guys are thinking about M&A moving forward?

Scott S. Scherr - The Ultimate Software Group, Inc.

I mean, the same as we always have. I mean, PeopleDoc was the sixth deal we've done. A deal we did before that was Kanjoya, which I believe was three years ago. So I think if the opportunity presents itself and if someone either through technology or through product that can make us stronger and they have a good culture, then we would look at it.

I think we're in the envious position that – because of our culture that, when people do – are growing companies and they do think – or the time comes where they're thinking about maybe, do they try and partner with someone else or do they keep moving forward with more investment dollars that both Kanjoya and PeopleDoc, they really came to us because of our culture, that they felt that it was a place that is – they were going to be with someone else and be part of someone else's family, that we would take care of their families. So I imagine that could happen more in the future, but we're not an acquisitive company; but, we're also not going to turn something down that makes us stronger.

Joe Goodwin - JMP Securities LLC

Thank you.

Operator

And next is Brian Peterson with Raymond James.

Alex Sklar - Raymond James & Associates, Inc.

Thanks. This is Alex Sklar on for Brian. Following up on the impressive wins in Europe and now that we're a few months past the PeopleDoc acquisition, can you just talk a little bit more about your international expansion ambitions and whether that's changed at all as part of – as a result of the deal? And then, maybe with that, just an update on the integration progress as far as getting PeopleDoc offerings into your unified suite? Thanks.

Scott S. Scherr - The Ultimate Software Group, Inc.

Well, as far as the international, I believe that our goal now is at $2 billion. They'll represent about 5% and we want to grow it, so that at $3 billion that they'll represent 10% of that. And what was the second question on the integration?

Alex Sklar - Raymond James & Associates, Inc.

Yeah. As far as...

Scott S. Scherr - The Ultimate Software Group, Inc.

We've already – I got it, I remember. So in our third quarter all team sales meetings, we've already started training all our sales people on it. We've been training our executive relations managers on it, who sell back to our base. And the plan is to roll it out in our January all team sales meetings. So coming out of the January sales meetings, the whole sales force and the whole executive relationship management team will be selling it.

Alex Sklar - Raymond James & Associates, Inc.

All right, great. Thank you.

Operator

And moving on to Steve Koenig with Wedbush Securities.

Steve R. Koenig - Wedbush Securities, Inc.

Hi, Scott and Felicia, thanks for taking my question.

Scott S. Scherr - The Ultimate Software Group, Inc.

Sure.

Steve R. Koenig - Wedbush Securities, Inc.

I'll limit myself to one here. So I realize PeopleDoc has some impact on your margin. You guys have been really good at trying to break it out for us and kind of estimate what it would be with and without. I'm just wondering though if we kind of look at the broader arc of your margin, your operating margin in the last couple of years, it'll end up being pretty flat, pretty good guide for next year. And I realize part of PeopleDoc, but I guess the question here is, kind of what you're thinking about longer term margin expansion? How much operating leverage do you have and when can we start seeing it?

Felicia Alvaro - The Ultimate Software Group, Inc.

Okay. With our margin expansion, we do expect that we will be growing it. Hold on, just one second. We're going to be growing our recurring revenues. If we grow our recurring revenues at about 20% a year, as we would expect, operating margins will expand by roughly 50 to (41:36) 100 basis points a year. However, if there is an opportunity in the future that will allow us to maintain that 20% recurring revenue growth for a longer period of time, we'll certainly consider it, but we do expect that we will grow our operating margin on the long-term.

Steve R. Koenig - Wedbush Securities, Inc.

Got it. Okay, great. Thanks, Felicia.

Felicia Alvaro - The Ultimate Software Group, Inc.

Okay.

Operator

Next will be Kirk Materne with Evercore ISI.

Peter Levine - Evercore Group LLC

Thanks for taking my question, it's Peter Levine in for Kirk. So I'll just one here. So to piggyback off of the prior question on Xander, that work during the quarter would say customer seem more enthusiastic about AI, especially Xander. So curious to know how the conversation with customers change, entering the year with Xander and how it's kind of changed exiting the year going into 2019 and kind of how does that help you competitively as you look longer term? Thanks.

Scott S. Scherr - The Ultimate Software Group, Inc.

Well, I think it's a story of our product and our technology moving forward. And they could see it firsthand in our Perception product. So it gives them a sense of what the present is and what the future looks like. So it's obviously talked about on every call with new prospects and our existing client base. So we believe we're in the best place for human capital management and from a product standpoint, from a service – and a service standpoint. So I think it – yeah it's everything to us.

Operator

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

Mark S. Marcon - Robert W. Baird & Co., Inc.

Good evening, and thanks for squeezing me in. With regards to the recurring gross margin, was that all PeopleDoc or was there anything else that was impacting that? And then I've got a couple of follow-ups.

Felicia Alvaro - The Ultimate Software Group, Inc.

In terms of Q3 or within...

Mark S. Marcon - Robert W. Baird & Co., Inc.

Yeah, Q3 relative to a year ago.

Felicia Alvaro - The Ultimate Software Group, Inc.

Okay. Well with Q3, it was actually pretty close to our expectations just a little bit less than what we expected. Keep in mind that a year ago, we had a less amortization of cap software than we do this year and we did have a couple of one-time expenses that came in during Q3 of this year, an example of which would be a team meeting for one of our groups that impact that particular gross margin.

Mark S. Marcon - Robert W. Baird & Co., Inc.

Okay. So that – and then obviously PeopleDoc and Xander would also have a little bit of impact, right?

Felicia Alvaro - The Ultimate Software Group, Inc.

Yes, it does. Given the size of PeopleDoc to Ultimate, it's not quite a significant but it does have an impact.

Mark S. Marcon - Robert W. Baird & Co., Inc.

Okay great. And then, for Scott, are you seeing any difference at all in terms of with all of your new capabilities, when we think about the new logos that have come on and the ones that are in the pipeline. Are you seeing any difference in terms of who you're getting them from? One old competitor longtime ago a partner, their bureau business is becoming smaller, so I imagine it's less of a fertile hunting ground, so I'm just wondering how we should think about that?

Scott S. Scherr - The Ultimate Software Group, Inc.

Pretty much the same. We get about 65% of our business from service bureaus, and the other 35% from in-house and ERPs. It really hasn't changed.

Mark S. Marcon - Robert W. Baird & Co., Inc.

Okay, great. Thank you.

Scott S. Scherr - The Ultimate Software Group, Inc.

Thank you.

Felicia Alvaro - The Ultimate Software Group, Inc.

Thank you.

Operator

And that does conclude the question-and-answer session. I'll now turn the conference back over to you for any additional or closing remarks.

Scott S. Scherr - The Ultimate Software Group, Inc.

Thanks for your support, everyone, and look forward to our February call, where we'll be celebrating our fifth championship. So all the best. Good night.

Felicia Alvaro - The Ultimate Software Group, Inc.

Thank you, bye-bye.

Operator

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